WEBMASTER NOTE: This is the unedited transcript of the Inaugural Public Roundtable for Financial Reporting Series on November 8, 2011 which we received directly from the transcriber. We are posting the transcript in this form to make it available as soon as possible. 0001 1 U.S. SECURITIES AND EXCHANGE COMMISSION 2 3 4 5 6 INAUGURAL PUBLIC ROUNDTABLE FOR 7 FINANCIAL REPORTING SERIES 8 9 10 11 12 13 14 Tuesday, November 8, 2011 15 10:00 a.m. 16 17 18 19 20 21 22 23 U.S. Securities and Exchange Commission 24 100 F Street, N.E., Washington, D.C. 25 Station Place 1 Multipurpose Room 0002 1 MODERATORS: 2 James Kroeker, SEC Chief Accountants 3 Mike Starr, Deputy Chief Accountant 4 5 PARTICIPANTS: 6 Mary Schaprio 7 Meredith Cross 8 James Doty, Chairman, PCAOB 9 Marc Siegel, Board Member FASB 10 Jay Hanson, 11 Loretta Cangialosi 12 Anna Dopkin 13 Gary Kabureck 14 Adam Litke 15 Jennifer Paquette 16 Stephen Penman 17 Scott Siefers 18 Pinto Suri 19 Christopher Begg 20 Terri Campbell 21 Steve Glover 22 Joseph Longino 23 Paul Munter 24 Mark Newsome 25 Gary Walsh 0003 1 PARTICIPANTS (CONT'D): 2 Dorsey Baskin 3 Gerry Czarnecki 4 Liz Gantnier 5 Diann Gross 6 Bradley Hunkler 7 Janet Pegg 8 Kevin Spataro 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 0004 1 C O N T E N T S 2 3 PAGE 4 Call to Order and Opening Remarks 5 5 Panel 1: 13 6 Panel 2: 99 7 Panel 3: 176 8 Concluding Remarks 230 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 0005 1 P R O C E E D I N G S 2 MS. SCHAPIRO: Good morning, everyone. Thank you 3 all for coming. 4 It's a real pleasure to welcome you to the Inaugural 5 Public Roundtable of the SEC's Financial Reporting Series. 6 You know, we created this series to provide a 7 permanent forum for identification of risks related to and areas 8 for potential improvements in the reliability and usefulness of 9 financial information provided to investors. And it's designed 10 to bring all stakeholders together in a thorough and balanced 11 examination of these issues. So it will help the SEC in our 12 capacity as the oversight provider for the financial reporting 13 system to coordinate responses. 14 This is an important series for the investors, whom 15 it is the SEC's mission to protect, for firms who value accuracy 16 and transparency in reporting and for the auditing professionals 17 on whom the financial system relies for verification of that 18 reporting. 19 In recent years, we've seen repeatedly how important 20 it is that financial standards and regulations keep up with 21 changes in the way our economy works. This is especially true 22 of financial reporting, the production of information on which 23 millions of decisions are made and trillions of dollars of 24 capital are allocated every day. 25 The ability for investors and others to assess an 0006 1 understanding of uncertainties inherent in reporting economic 2 events, it's fundamental to the functioning of a market economy. 3 Standards and rules must be as clear and 4 understandable as possible in a complex business environment so 5 that financial information is communicated accurately and 6 transparently. 7 In addition, given the rate of change in today's 8 financial world, it's important that we act aggressively to 9 identify the issues in the financial reporting system today 10 before they become tomorrow's problems. 11 I believe that this series of roundtables will 12 become a key part of this effort. Fostering discussion of 13 existing pressures and emerging issues within the financial 14 reporting system and pointing us towards their resolution. 15 The composition of these roundtables reflects the 16 fundamental pillar of the financial reporting series. That 17 solutions to the reporting challenges uncovered in this process 18 must be arrived at holistically through a process that brings 19 all market participants together for a discussion. 20 That is why I am so pleased to see a full spectrum 21 of participants today. Representatives, of course, from the 22 SEC, the PCA, will be in FASBI, but also representatives of the 23 accounting and auditing profession, academia, the investor 24 community and the businesses whose finances are being reported. 25 Our efforts to reflect emerging issues and changes 0007 1 in the business environment will only be effected if there is 2 frank and detailed dialogue among all the affected stakeholders. 3 And it's equally important that this dialogue be continued over 4 the long term. 5 We intend for the financial reporting series to 6 become a critical and ongoing part of the SEC's work to protect 7 investors and enhance our capital markets. It will be a 8 continuing series anticipated to be held three times a year to 9 explore issues of significant importance to the financial 10 reporting system and for which there is no similar forum today. 11 Uncertainty is an important and fascinating subject 12 for our first forum. But this subject is just the beginning. 13 Putting in place a mechanism for considering issues that need 14 immediate attention will benefit every individual and 15 institution that makes decisions based on financial information 16 that is disclosed by our public companies. 17 Thank you once again for coming today and for making 18 the first in an ongoing series of roundtables a success. 19 Before I turn the microphone over to the SEC's Chief 20 Accountant Jim Kroeker, I wanted to take a moment to acknowledge 21 my colleagues on the Commission who are here today. Their 22 presence I think speaks to the importance of this initiative. I 23 also especially want to welcome our newest commission, Dan 24 Gallagher, who joins us in this his first public forum since 25 returning to the Commission just yesterday. 0008 1 And now Jim Kroeker has a few words to say. Thank 2 you. 3 MR. KROEKER: Thank you, Chairman Schapiro, and 4 welcome to each of the participants. We have three panels today 5 of out - outstanding individuals to provide a perspective at 6 this inaugural financial reporting series. And I want to thank 7 each of you for taking the time out of your otherwise extremely 8 busy schedules, I'm sure, to share with us your perspective and 9 to share that with us in a coordinated fashion with the SEC, the 10 PSOB and the FASB. 11 This SEC inaugural financial reporting series 12 roundtable is an important event. It shows our commitment to 13 continuing to make sure that we don't have gaps in a regulatory 14 process and that we tighten any perceived lack of coordination 15 and we enhance that coordination between the FASB, the PCOB and 16 the SEC as - as demonstrated by each of our commitment to the - 17 to the series. 18 I want to also acknowledge the other staff at the 19 table. In this case, Meredith Cross, who is our Director of the 20 Division of Corporation Finances. We go forward. We will 21 continue to have a coordinated approach, not just with the FASB 22 and the PCOB but internally. So, Meredith, thanks for joining 23 us. This is squarely something that is of interest to all of us 24 when we talk about uncertainty, how we communicate that in 25 financial reports. I suspect we'll have a lively discussion. 0009 1 At one of the spectrum you could think of this as 2 an issue of what is really the role of financial reporting 3 itself. Is financial reporting something that we might have 4 thought of 50 or 100 years ago where you're simply reporting 5 upon that which happened in the past? Has, or should, financial 6 reporting continue to evolve to reporting that which is a little 7 bit less certain? The unknown future events, where is - what 8 are the tradeoffs? What is the desired outcome? Should 9 accounting look more like financial analysis or the role that 10 analysts might have traditionally played? 11 And, again, I don't think these are easy or black 12 and white questions. I don't think you could say, well, 13 financial reports should only have this or should only have 14 that. But that's why we're seeking the input of this group. 15 I don't suspect that every financial reporting 16 series roundtable will be quite as weighty an issue. I think 17 they'll be equally as important but this really is I think at 18 the heart of what do investors want from financial reports and 19 how can those charged with executing deliver on that? How can 20 accountants internally deliver and then what is the impact to 21 auditors? 22 So I think it's particularly important that we have 23 such a wonderful group together. 24 The first two panels really will focus on the 25 investor perspective; what are investors looking for from 0010 1 financial reports. We have a combination of capital market 2 participants but that really is the focus of the first two 3 panels. With the third panel focusing on the interaction of 4 then how can we deliver; what are the implications to auditors, 5 what are the implications to those providing the information. 6 We will take the input that we hear today, both 7 internally as the SEC staff, determine any appropriate courses 8 of action. We'll also continue to coordinate closely with the 9 FASB and the PCOB. 10 Many of you know that we have quarterly liaison 11 meetings at senior level between the organizations. I suspect 12 that the input from these series will be top of mind on our 13 agendas as we go forward in those types of coordinated responses 14 to the financial reporting system. 15 With that, I'll turn it over to the Chairman of the 16 PCOB, Chairman Doty, for any - any -- any introductory remarks 17 that he might want to provide. 18 MR. DOTY: Thank you, Jim. 19 First, I want to thank Michael Starr and Jim Kroeker 20 for their vision in thinking of this series. I had been at the 21 PCAOB only a few weeks when they began to discuss this. I know 22 the kind of effort and thought that's gone into it. I 23 especially want to thank Chairman Schapiro for including us in 24 this important and landmark series. 25 It is in my mind an exemplary of - case of 0011 1 inter-agency cooperation and it is going to expand and make more 2 effective the ability of the PCAOB to do what we are supposed to 3 do, which is to provide rules that enable auditors to audit 4 effectively. 5 Here as I am with my colleague and board member, Jay 6 Hanson, and our Chief Auditor Martin Bauman. We feel privileged 7 to have the benefit of this SEC initiated outreach. We're going 8 to be listening carefully to determine how we can work more 9 effectively with both the SEC and the FASB to do that. 10 With that, I will thank you again, and sit back. 11 MR. KROEKER: And I'd also like to turn it over to 12 FASB Board Member Mark Siegel for any introductory remarks that 13 you might have. 14 MR. SIEGEL: Thank you, Jim. It's really great to 15 be here. 16 I guess, first, I wanted to convey my regrets from 17 Chairman Leslie Sideman who would very much liked to have been 18 here today. Unfortunately, she had a long standing commitment 19 to attend and chair our small business advisory committee 20 meeting today. And - and - and it's at a time now when there's 21 a very, very healthy dialogue going on about what should 22 standard setting look like for non-public entities. And she 23 felt that she had to be there rather than today. 24 At the same time, I'll just convey my understanding 25 that, I, you know, having - knowing Leslie, that no one has been 0012 1 a stronger supporter of the idea of the vision of this series 2 than Leslie. And I know she's dedicated to helping it succeed. 3 She believes that it's critical. That the issues that transcend 4 the organizations, the PCAOB, the FASB and the SEC, get 5 addressed in a coordinated way and she looks forward to 6 continuing her involvement with the financial reporting series. 7 And she thanks everybody here for attending and participating in 8 this event. And I know that she will look forward to hearing 9 what happened today. And - and - and with the progress that 10 we've made will be. 11 From my perspective, I think it's absolutely 12 fantastic to have all three organizations here today working 13 together. In my former career as a user of financial 14 statements, my - the conclusions that I drew, I drew upon the 15 entirety of the financial reporting package, whether it's the 16 audited financial statements, whether it's the MD&A, whether 17 it's supplemental information that's provided outside of - 18 either of those. I had to look at all three pieces of 19 information. And - and so having either redundancies or gaps in 20 that was certainly not helpful. And so having a coordinated way 21 is just critical for all of us to work together on solutions to 22 improve the information set that's out there to - to allocate 23 capital. Kudos to the SEC, and particularly Jim and Mike and 24 Chairman Schapiro for in the midst of all the rule making that 25 this organization has to do day in and day out, to find the time 0013 1 to - to put together this - this inaugural roundtable today and 2 put the whole series together. So thank you very much for that. 3 Measurement uncertainty is a great topic to start 4 with. We have so many ongoing projects now where measure 5 uncertainty is - is - is inherent in the - is the accounting 6 that's potentially going to be proposed. The classification and 7 measurement of financial instruments in the balance sheet, it's 8 critical there. Hedging, is something that we need to work 9 together with the ISB to propose moving forward. Accounting for 10 credit impairments at financial institutions, it's critical. 11 Insurance contracts, lease accounting and revenue recognition. 12 As we look to improve the accounting and the 13 reporting in all these areas, how we and are colleagues at the 14 SEC and auditors at the PCAOB, how we think about and deal with 15 measurement uncertainty in a cost beneficial way, it's going to 16 be a critical success factor to - to - to those standards that 17 we put out. 18 So with that, I -- again, thanks to all of you for 19 participating today and I look forward to a very informative and 20 instructive day. Thanks. 21 MR. KROEKER: I won't go through the backgrounds of 22 each of the panelists. Their bios are available online so we 23 have a wonderful mix of participants today. For those want to 24 be recognized, I would suggest that either just raise your hand 25 or turn your tent card on its side. We'll certainly try and 0014 1 make sure that we hear from anyone who wants to provide us a 2 perspective on any question that we pursue today. 3 And for those in the public that want to provide a 4 perspective, we have a background paper that is available. We 5 have a link on our website that you will be able to track the 6 financial reporting series. That paper is out there. There are 7 a number of questions that we would appreciate any input. 8 Likewise, for those who have recommendations of 9 topics that you think would be important to address in the 10 future, I do want to highlight that as well. That this is 11 intended to address important topics before they become of 12 crisis level. 13 So let us know about those. And there's an open 14 link on our website to do that. 15 With that, I'll jump right in to the discussion. 16 And I thought I might tee up a question that hopefully gets some 17 response. It's pretty broad in its scope. And that really is, 18 what are investors looking for from financial reports, 19 particularly as it relates to the role of uncertain things that 20 may happen in the future? 21 And if we can't get a dialogue going on that, we 22 could drill down to some more specific questions. But I don't 23 think we'll have an issue with that. And I'll turn the table 24 over to really anyone that wants to respond to that question. 25 MR. SIEFERS: I'd be happy to start. Scott Siefers 0015 1 with Sandlar and Ells. 2 I think just broadly three topics I think investors 3 look for. My own background, by the way, I'm a bank analyst so 4 fairly specific, but nonetheless, the question you pose is, as 5 you said, very broad. So I'd say three things at the outset; 6 transparency, comparability, and objectivity. 7 I think one of the main criticisms that I hear from 8 the investment community just with - with accounting reporting 9 generally is that it's simply very difficult to compare, you 10 know, for example, one bank to another. Try as we might, you 11 know, a lot of banks to - to - to take a step back, you know, 12 one of the main criticisms of banks is that they don't have 13 transparent balance sheets or income statements to begin with. 14 So virtually whatever we do, is a bit of an uphill 15 climb. But nonetheless I think to - to the extent that we can 16 look - try to focus on those three things, those are by far the 17 overriding themes I think investors are most interested in. 18 MR. KROEKER: Yes. 19 MS. DOPKIN: Anna Dopkin with T. Rowe Price. Thanks 20 for giving us a chance to voice our opinions. At T. Rowe we 21 really also are looking for transparency and comparability. As 22 someone who used to run a financial services fund and it's more 23 diversified at this point, we find that, you know, there's lots 24 of disclosures that are out there but the application is so 25 broad at times it becomes meaningless. You know, a current 0016 1 topic today is, you know, DVA adjustments arm the banks and the 2 bankers and there's just not a lot of consistency from one 3 company to another. One company will discredit the measurement. 4 Another company will endorse it but they'll use different 5 assumptions behind it. 6 The general lack of comparability becomes very 7 frustrating for an investors and the companies because of the 8 lack of guidance they can sometimes hide behind trying to 9 provide the useful information until they feel that they have, 10 perhaps, a gun at their head if their stock price is going down, 11 then you find a little bit more information. And we're starting 12 to see a little bit of distinguishment between the individual 13 reportings of the companies this quarter. 14 So we're really looking for just more guidelines to 15 the companies and some investors, like energy and some others, 16 there's specific guidelines; what discount rates to use, how to 17 come up with the methodology to analyze the reserves in oil and 18 gas companies but in banks, which are just so big and full of 19 lot of what-ifs, there's just not - not that same kind of 20 comparability. 21 MR. LITKE: Adam Litke. I think one thing to think 22 about especially on the comparability front when we talked about 23 banks is how do we look at even just classification of assets. 24 I think somebody mentioned the issue of level one, level two and 25 level three assets, or at least alluded to it. 0017 1 And nobody wants to have a level three asset. On the - on the 2 banking side when you do loans, if you have national loans, you 3 have something called shared national credits. But - but you 4 don't have something called shared national level three assets. 5 So banks don't want to call things level three. They - they do 6 this - they jump through tremendous hoops to make everything a 7 level two asset. 8 And in a sense if there was some guidance to say, 9 look, this is level three, now give us your best estimate as 10 opposed to everyone being allowed to make their own rules about 11 it, in the sense if you can't do what you'd like the auditors to 12 sign off on, they have to sign off on the process. Right there 13 for the level three asset, they're not going to sign off on the 14 numbers. At least if we had agreement about what was level 15 three, I think that would go a long way towards helping things. 16 MR. SURI: Pinto Suri from Friday and Crumbline. 17 We're investors mainly in preferreds and covering basically 18 financial institutions. 19 Yeah, I think I would qualify the transparency issue 20 by saying that it's not so much transparency as consistency of 21 application of the same particular accounting model. And in 22 looking at insurance companies, that becomes even more 23 pronounced for a variety of reasons. Not only do you have items 24 like DVA, showing up off of liabilities that really are 25 insurance liabilities, they're not derivatives, but are being 0018 1 treated as derivatives. And what that does is when you see this 2 kind of volatility quarter to quarter and you know that this 3 can't be cash settled, it can't be net settled, it can't be 4 traded. Is an insurance product. It's priced as an insurance 5 product. And then you see liabilities rising by several billion 6 dollars one quarter, declining to a few billion the next 7 quarter. It reduces confidence. 8 So if we're talking about financial institutions 9 that are confidence sensitive entities, having this kind of 10 issue show up repeatedly, it reduces investor confidence in the 11 numbers that are being presented to us and forces us to then go 12 back to management and say, we need more operating numbers, 13 which are non-gap. 14 And that's something I think is a bigger concern, 15 particularly when we look at insurance companies. 16 MS. PAQUETTE: Jennifer Paquette with Colorado Para. 17 We manage a fair amount of our assets internally and when 18 visiting with our equity and fixed income analysts and portfolio 19 managers many of the points that have already been made I'm 20 hearing from them as well. 21 Whenever we're discussing about this - discussing 22 the measurement uncertainty issue the focus really from them is 23 on receiving more of the input drivers on how these measurements 24 are being determined. 25 While we recognize that corporations may be hesitant 0019 1 to provide some of these inputs, we're aware that they've got to 2 use something. And some of the better disclosure statements 3 will talk about what sort of - of matrix they consider when 4 coming up with their measurements. But they stop short of 5 sharing what any of - of the ranges of those matrix might be and 6 simply give a very high level description of what those inputs 7 are. 8 We're not looking for financial statements to do our 9 financial analysis for us. We would prefer that disclosures 10 would progress to a level where - at a higher level of 11 understanding the measurement uncertainties, we have some of the 12 inputs that entities are considering when they come up with 13 those numbers. So we can assess whether we find those valuable 14 numbers or would prefer to do our own sensitivity analysis. 15 MR. KROEKER: Others or from a preparer's 16 perspective. Certainly you hear both Gary and Loretta from 17 investors all the time. What are they looking for when you talk 18 to them? 19 MS. CANGIALOSI: So amazingly the comments around 20 transparency, comparability, and objectivity, those will be the 21 things that people are looking for. It's how we arrive at these 22 same answers seems to be the interpretation of what we - we 23 think is transparent or comparable. I think the difficulty in 24 comparability sometimes - and I'm not from the banking 25 institutions so I really can't figure out what your issues are 0020 1 with them - but from - for our own selves is in trying to 2 measure things like intangibles, which are clearly more level 3 three when you do a business combination, then they are any kind 4 of level one or level two. It is quite difficult to do because 5 you have to make a lot of assumptions about when you're working 6 with in process R&D you've got to look at things like, okay, 7 what would - what's the indication for this? If I have a 8 medicine, what's the indication? What would the - what's the 9 future potential market? So that would make a lot of very broad 10 sweeping assumptions on this. And I have to figure out what's 11 the possibility of success. 12 And, you know, quite honestly, it's a guess. Nobody 13 knows for sure. We've all followed the press. We know how 14 things work at the FDA. Sometimes things come out right. 15 Sometimes you wind up with a bump in the road, a bad clinical 16 trial. You need to go back and do it again. These - these 17 things are expected in the industry. 18 And trying to project that forward in a model, you 19 know, may lead to very different views by companies. I mean, 20 you try to use a hypothetical market participant but let's face 21 it, that's difficult to do. Not everyone thinks alike. I think 22 uncertainty itself is something that we - we have. We have to 23 get used to. We live it every day in business. And it's - I 24 always like to think of it as points on a line and there are 25 many points that are valid. It's a matter of what you're 0021 1 choosing. I mean we, again, have spent a lot of time in our 2 disclosure saying, "Hey, here's what we did, these are the kinds 3 of inputs that we used and, by the way, we may not be right," 4 because we don't know how else to convey it. 5 MR. KABKORECK: Thanks, Jim. A few thoughts. 6 I think all the investors here, every concern or 7 question they raise is valid and appropriate if you're an 8 investor, regardless of equity investor, credit investor, 9 whatever. I think from a preparer's point of view I'll take 10 the three items investors want. If I take transparency and 11 objectivity separate from comparability. I think - I think 12 they're a little bit different because transparency, I think, is 13 very much internally controlled by companies. And I think the 14 same is true for objectivity. 15 I think comparability to compare between companies 16 in an industry or even between industries is, I think, most 17 companies probably think their financial reporting is 18 appropriate for their circumstance, for their book of business, 19 for their management culture and whatever. So I think to 20 improve comparability is probably more a regulatory action from 21 your organization, from elsewhere, but I think objectivity and 22 transparency, I think, are more internally controllable. 23 And whatever way your tools or devices in the market 24 place the regulators can do to push towards improving there, I 25 think I'm very receptive to it personally. 0022 1 I do think it's important to keep in mind that 2 virtually everything on a balance sheet is loaded with 3 estimates. I mean, even the - Loretta and I were talking 4 before. Even cash, I think, is pretty objective but if it's a 5 country that's got blocked currency, it's not readily available, 6 if you've got something else where it's readily available but a 7 high tollgate tax and you don't need it for operational purposes 8 in that country, is it really equal cash to what's in your U.S. 9 Main depository account and so on. 10 So with everything loaded with various estimates of 11 uncertainties, I think it would be important for, you know, this 12 camel, this group over time to - well, what are the critical 13 one, two or three things. Because, I think, you don't want to 14 have a statements and the footnotes so long that you get the 15 buried facts doctrine and you just can't find it. 16 So I think it's important to narrow down to the 17 couple. And whether it's uncertainties of future cash flows, I 18 think is, perhaps, more important that uncertainties of future 19 income or amortization rate is wrong. That's at some cost 20 already. 21 MS. CANGIALOSI: Just to build on that. 22 I think when I look at this, I agree with Gary. I 23 mean, I think we have to - we have to figure out what are the 24 biggest issues that we want to target because it really goes by 25 the nature of the asset. That - that is critical to 0023 1 understanding how we can achieve comparability or transparency 2 if that's the issue. 3 But you have to focus on what is the asset or 4 liability that you're trying to really deal with because the 5 answer is likely to be different based on that. 6 So I do think that it's - it's not only that but it 7 really is helpful to understand exactly, kind of, how are you 8 using that number. Are you using it to tie into short-term cash 9 needs or are you using it to, you know, value the company based 10 on a - on a future prospects? I'm not exactly sure in some of 11 these. Again, it's really the nature of it that you need to 12 look at; how it's being used. Because that could also tell us 13 what disclosures might be more useful for you. 14 MR. KABURECK: The risks if you take an identical 15 security, U.S. Treasury Bonds, I mean, one company gets held to 16 maturity and they value it one way. Because they really are 17 traders. The exact same instrument it might be valued 18 differently and so on and likewise. I mean, it's held to 19 maturity and it's - you've got the OCI element, so even 20 identical things are not necessarily getting measured 21 identically. So the business model starts to get to play a role 22 in here, too. 23 I'm not suggesting I mean how to deal with that at 24 the moment, but, I mean, I think it's important, I think, of 25 investors to have a good understanding of the company's business 0024 1 models they're following. Now, whether that's a disclosable 2 event or sort of their business to deal with. I actually don't 3 know that answer. 4 MR. KROEKER: Go ahead. 5 MR. PENMAN: Just an interesting point when you 6 talked about assets being valued differently at different 7 companies. Sometimes they're actually valued differently in the 8 same company even when they have the same accounting treatment. 9 So, for example, I happen to go through the 10 Wachovia-Wells Fargo merger and one of the interesting things 11 was when Wells Fargo bought Wachovia. Sometimes they owned the 12 same assets. And all in the Held for Sale book and in the 13 purchasing accounting the Wachovia assets were held at what 14 Wells Fargo deemed to be the market value of those assets and 15 acquired on that day whereas if they owned the same asset in 16 their Held for Sale book they could keep it at their original 17 purchase price. So they had the same asset, even the Held for 18 Sale portfolio had two different prices. 19 MR. KABURECK: That sort of points out some of the 20 ultimate limits of financial accounting and reporting what it 21 does. 22 MR. KROEKER: And I think that's a wonderful example 23 of the one measure probably incorporates more uncertainties is 24 the allocation of purchase price to estimate a market for a held 25 for sale or a held available for sale asset versus a historical 0025 1 cost value. And obviously in those - I mean, you have to 2 determine fair value and disclose it for both whether it's 3 recorded or not. 4 But a couple other examples, and I think getting 5 back to the "what do investors want and how do they use it." 6 Take an example like goodwill and the impairment of goodwill. 7 If you look back historically where goodwill was at a cost model 8 subject to amortization over an estimated useful life, certainly 9 subject to impairment testing but probably occurred less 10 frequently because the number is being amortized. We're now in 11 a model where we put goodwill on the balance sheet and only 12 write that down subject to impairment, which is really, in most 13 cases, looking to the future prospects of the entity as a whole. 14 So now we're taking very uncertain things; estimated revenue 15 over the next 40 years; estimated costs or expense over the next 16 40 years and bringing that back to a number that we compare to 17 the value of goodwill. 18 That's inherently, I think, more uncertain than what 19 we had done historically. 20 What is it that investors are looking to when they 21 see that impairment of goodwill? You know, I've heard some say 22 that they get a lot of meaningful information about future 23 prospects, but, of course, that's only then limited to 24 situations in which goodwill is impaired. So that when the 25 value of the entity might be going up, you don't see the same 0026 1 measures going through the income statement or, in that case, 2 and the value of goodwill. 3 Or take maybe even a more controversial topic, 4 because I think we might as well get them on the table if we're 5 going to have a discussion. Let's get the controversial topics 6 on the table. Take something like the measure of an enterprises 7 own debt. A lot of press recently about the requirements, in 8 some cases, either regulatory requirements or the option to mark 9 your own debt; to estimate it fair value. 10 Certainly inherently more uncertain than the 11 contractual amount of debt that you owe. People are doing that 12 to provide, presumably, meaningful information to investors. 13 What is it that investors benefit from that? Is that something 14 investors are looking for? Particularly when you talk about 15 enhancing comparability. Those trade-offs of providing more 16 forward-looking or results of analyses of future transactions 17 seemed to hit upon what accountants used to call the - the 18 trade-off between relevance and reliability. So something might 19 be more reliable if I put it on the books at cost but is that 20 more relevant? 21 I think getting to the heart of those issues would 22 be - would be very helpful for us. 23 MR. PENMAN: Stephen Penman, Columbia University. 24 I manage money, a very small amount of money. But 25 we - we have a lot to do with fundamental investors at Columbia 0027 1 because we're in the Benjamin Graham tradition. 2 I'd say one criterion - you brought a high level 3 question here is I think investors look for certainty in the 4 accounts. Okay? And it's all a question about handling your 5 uncertainty but in the - I think in the fundamental tradition, 6 Benjamin Graham would say, hey, listen, understand what you 7 know, and separate from speculation. And when your accountants 8 do your work, don't mix speculation with what you know. Because 9 I need an anchor in the financial statements to - to build on. 10 Okay? Leave the speculation to me. 11 So, for example, do I want a fair value core 12 deposit? Okay. Because I want to have a balanced book with the 13 mortgage loans. Well, that's a lot of speculation. Okay? And 14 it gives me an income statement which is just changes and 15 estimates and I lose my anchor. 16 I'm trying to get something in terms of information, 17 the fair value of the core deposits, but I'm going to destroy 18 the information that I - I can anchor on. 19 I think this is probably our objectivity aspect of 20 it. Okay? Just elaboration of that. And, of course, this is 21 the issue of the day to the extent in which you want to put 22 "deal with uncertainty" in the accounts versus in disclosures 23 and footnotes and so on and where you draw that line. 24 MR. SURI: If I may? 25 MR. KROEKER: No. Go ahead, please. 0028 1 MR. SURI: I think - I think that is the issue of 2 the day. And I think when we look across the financials 3 landscape so you've got two major industries, banks and 4 insurance companies. And you see in one where you've got still 5 a measure of amortized costs and you've got a level of stability 6 in the accounts. 7 And I think as an investor what is most useful is to 8 be able to have a contrast. It's the asymmetry of information 9 that drives an investment decision. 10 So you have a management view of a base case of what 11 they think it takes to remain a going concern. That's 12 important. 13 What we're seeing in the new, upcoming proposals, 14 particularly for insurance contracts, as well as, I think, to an 15 extent even for financial instruments, challenges that very 16 proposition. And I think this asset liability view in our view 17 is far from settled, eradicaly. And practically speaking, I 18 think it leaves us at a - at a grave disadvantage. Not only 19 because of volatility but because you get marks like, own 20 credit. 21 So my liability fair value has dropped. Why has it 22 dropped? It dropped because market thinks the value of my 23 assets has dropped. So I'm about to go bankrupt but I book a 24 four billion dollar gain? 25 It - it - I think it defies credibility to have 0029 1 accounting like that float through. And it's not a question of 2 adjusting it out. When you see accounting like that and then 3 you can't trace it through the financial statements in the 4 footnotes, that really reduces confidence. And it's that 5 confidence that then shows up in higher cost of capital, in 6 reallocation out of particular sectors. And I think that's 7 something that should be given some thought to. 8 I think standard setting and accounting should be 9 evidence-based. That - that really is a fundamental. And the 10 only other point I'd make is business model is paramount. 11 For a broker-dealer, absolutely everything should be 12 marked at market. But even there, their own marks are leading 13 already in third quarter '11. You're already seeing for broker 14 leaders core EPS. What the heck is core EPS? For a 15 broker-dealer, excluding one credit marks. That's not - that's 16 a slippery slope. And I think putting on a facade of 17 mathematical precision, whether it's probability weighted 18 estimates or, you know, confidence intervals or anything like 19 that, I'm reminded of Lotfi Zadeh, founder of fuzzy logic and 20 the principal of incompatibility. 21 As the systems complexity increases, meaningful 22 statements lose precision and precise statements lose meaning. 23 I think it would be instructive to keep that in mind, because as 24 we start putting on all kinds of mathematical constructs on 25 things that are inherently uncertain, you will just open up to 0030 1 more lack of confidence down the road. 2 MR. SIEFERS: Just a couple of additional 3 statements. 4 I think to a certain extent along the lines of 5 Pinto's comments, but I just wanted to react to a couple of the 6 exam - examples that you had used; goodwill and evaluation 7 adjustments. 8 I think more and more within the investment 9 community I see people just saying something to the effect of, 10 "I can't figure it out, I'll assume it's bad and I'll move on." 11 But, you know, just to - to react to - to the examples that - 12 that you had used. One, goodwill, you know, at least in the 13 banking space, you know, I'm finding more and more investors 14 simply tune it out, you know. 15 goodwill really does - does two things. One, the 16 addition of a lot of it has simply hurt your tangible capital 17 ratios. And then, two, the addition of a lot of it puts a cap 18 on what you can do or what can happen to your stock prices just 19 by virtue of more goodwill equals, you know, presumably a higher 20 price to tangible book valuation. 21 So, you know, from that standpoint, I think in many 22 cases the market has - has simply taken goodwill, removed it 23 from the equation almost entirely. And devaluation adjustments, 24 DVA's, that's - that's obviously a much more esoteric concern. 25 But I'm afraid the media has really turned that into a little 0031 1 bit of a circus of - in a lot of ways, you know, appropriately 2 so because I think that - kind of the humor in the investment 3 community is - is you can book your biggest gain when you have 4 the least likelihood of being a going concern, you know, so - 5 I think largely, you know, the more certainty that 6 we can introduce in the financial statements, the better. You 7 know, particularly when you go through a crisis like we had in 8 the past couple of years; at least in the financial space, i.e., 9 banks, you know, confidence is key. So to the extent that, you 10 know, you're going to go through a key or a kay, you have to 11 weight through, you know, a thousand pages of estimates that I 12 may or may not be able to figure out in a timely manner or in a 13 comprehensible manner, the certainty aspect to things is - is 14 incomparably significant. 15 MS. DOPKIN: I was just going to add, I mean, today 16 over 60 percent of the S&P 500 financials x the rates are 17 trading well under book value. That's a very high percentage, 18 so, I mean, I think it speaks to the fact that people don't 19 understand some of the adjustments that are being made. 20 You know, if we're going to have to live with the 21 DVA, then the company should have to give us the balances, give 22 us the duration. Something that we can try and estimate how 23 they're even getting to these calculations. But at the end of 24 the day, it really, you know, as Pinto and Scott said, it just 25 doesn't make sense why we are giving a company credit as they're 0032 1 about to be on their death bed. 2 So I think it either needs to be fixed or a lot more disclosures 3 need to happen. 4 And, you know, in terms of just general transparency 5 and, you know, take away, you know, financials highly complex, 6 you know, move to something like the food companies. 7 You know, we took a look at the top ten food 8 companies over the last ten years to just kind of come up with a 9 concept of clean or not clean earnings and what's above the line 10 and below the line. Very simple: plant closures. Companies 11 have to rationalize all the times lines that they're running 12 whether it's, you know, Pfizer or, you know, it's a restaurant. 13 People - regular things have to happen over and over. Maybe 14 it's for a different product or a different location, but you 15 have 75 percent of the companies are probably trying to sneak 16 things below the line. 17 And you have 25 percent of the companies, maybe, 18 that are - that are good and are reporting clean numbers. But 19 only two out of ten companies over the last ten years have not 20 tried to sneak things below the line. And then some are better 21 at pulling it out and telling investors, we don't want perfect 22 certainty otherwise there's not going to be anomalies in the 23 market and there's not going to be, you know, a chance to, you 24 know, try to buy stock a and b and see which goes up more or 25 goes down faster. 0033 1 But there just doesn't seem to be the consistency 2 across industries on very simple items, too. 3 MR. KROEKER: I'm enamored of the idea of reporting 4 clean, know what you know and then talk about the un - 5 uncertainty whether that's in the financials or otherwise. But 6 as - as Stephen described them, at least when I hear that - that 7 - that initially rings something with me, but I think putting 8 myself in the - in the position of - of somebody trying to set 9 accounting standards, if you think of one of the issues in the 10 financial crisis was not just comparability but transparency 11 around lending activities and the credit that you've extended. 12 And in any model, uncertainty seems inherent in that unless 13 we're just going to go to a strict cost model. I think that's 14 really where the rubber starts to hit the road is 15 what is it and then how, if we have an anchor, how do we convey 16 that certainly not everyone looks the same. Not everyone's 17 loan is at 100 cents on the dollar. How do we do that? Of 18 course we're trying to project that which we think would default 19 either at a fair value basis or otherwise. So I'm really 20 interested in, you know, you hear words like mixed-attribute 21 model and you wonder why people sometimes say that as if it's a 22 bad thing. In any other context you might want to know multiple 23 attributes before you bought an asset. 24 And so how you can provide more information about 25 here's the cost but here's what I expect. I - I don't know if 0034 1 there's a way to think about operationalizing that. 2 MR. PENMAN: I think that's a very good situation to 3 look at. You know, the proposals from - I think the big 4 conceptual issue is whether you want an asset liability, balance 5 sheet focus or an income statement focus. And what sort of 6 business one is good for and what sort of business one's not 7 very good for. 8 Those try to sort out their conceptual framework. 9 And they've tried initially taken a balance sheet. Okay. So on 10 mortgages, on loans, the idea is now that you try to get them at 11 value. Okay? So what do you do? You mark them to market, 12 level one. And then you bring the bubbles into the financial 13 statements. Thank heavens we didn't have that in 2007 or things 14 could be far worse. If everything had been marked to market. 15 The bubbles come in the financial statements. 16 Fortunately the gains would go through to OCI rather than to 17 income. 18 If you got level three, of course, you've got 19 estimates. And that's - that's additional problems and 20 essentially your income statement just becomes changes in 21 estimates. In a business way, you're basically borrowing - your 22 arbitraging, borrowing lending rates, an income statement 23 business. 24 If you amortized historical costs, it's level three, 25 okay. We do some sort of perspective, reserving. And the 0035 1 question is, how - how would you get out of this dilemma? And 2 here's the solution. It's historical costs but it's 3 conservative historical costs. 4 A bank makes a loan and it - it's - what's it doing? 5 It's taking on credit risk. When we account for a merge sign 6 concern, we say, look, we're not going to be back you until we 7 get the spot sale and the customers delivered. Okay. With high 8 degree of uncertainty. 9 When the bank makes a loan, a bank is to take on 10 credit risks. So that's the question. In my mind, you want to 11 bring in accounts when you're fairly certain that you're 12 actually getting the pay back of the credit risk. 13 So here's an accounting. Book the loan at the loan 14 amount for a few years, whatever it takes, record interest on 15 the loan at the risk free rate. That's the time value of 16 money. And - until quote "Credit worthiness," has been 17 established. That may be at origination. Okay. And not for 18 subprime line. 19 And then recognize this credit spread between the 20 risk free rate and the - and the foreign rate. It may be 21 amortized out a few years. I think that's very good accounting 22 because it's actually - you just want to know the customer can 23 pay. Okay? And it gives me an earnings I can really attach to. 24 25 Yes, we can have disclosures of fair values, if you 0036 1 wish, in the financial statements. Understand that they could 2 be bubbled they could be bubble prices on the loans. But - and 3 the problem with fair market accounting, for the mortgage loans, 4 which is a proposal, is, of course, you've got to match the book 5 on the other side. And that's a real problem of matching your 6 core deposits. The original price was to actually try and build 7 in the goodwill on the core deposits by - by projecting what 8 your customers are going to be in the future, which is very, 9 very, in my mind, very against the way we do - we do accounting 10 for a manufacturing concern. We don't book for future revenues. 11 When someone does that, you guys here put them in 12 jail. And the proposal is to get the - get the goodwill on the 13 core deposits, you know, you actually sort of reject that. And 14 then of course your income statement, then, just becomes changes 15 in these estimates. And you lose the quality of your income 16 statement. 17 So that's - I think that's a good example of a way 18 of sort of getting - getting certainty into the statements. 19 Okay? 20 You know, I got the feeling, if - if we had that 21 sort of accounting, yes, we would have had that - we would have 22 had that financial crisis. But, you know, maybe it wouldn't 23 have been as bad. Because banks would not -- up until it's 24 reasonably, reasonably assured that you're really got it. 25 Because prices and estimates suggest speculation on the 0037 1 financial statements. And prices - prices can be informative, 2 but they're also speculative. 3 MS. CANGIALOSI: So I'm finding this conversation 4 very interesting. And I guess when I look at the financial 5 statements, to me, uncertainty's all of the place in the 6 financial statements. In particular, we've gone to fair value 7 for a lot of things in the financial statements and the balance 8 sheet, in particular. So, you know, when you say you - you 9 don't book revenues, well, when I have to figure out the value 10 of an intangible, I actually have to sit there and try to figure 11 out what the cash flows on this will be for the next 20 years. 12 Okay? 13 So in - in fact, they're making these, you know, 14 ten, fifteen, twenty year estimates of cash flows in the future 15 for a potential product. There couldn't be more speculation in 16 there if I tried. 17 MR. PERMAN: But I think that's a specific 18 transaction, right? When I'm buying - 19 MS. CANGIALOSI: No, no. That's not a specific 20 transaction. That's just a measurement of something I've 21 bought. So when I do a business combination, I've bought that 22 asset, I've got to measure it now. But I'm - it's highly 23 speculative, obviously. It's got lots of assumptions built in. 24 You know, if somebody can - can actually come up with a, you 25 know, 15 year forecast for a product that hasn't been invented, 0038 1 you know, that's - that's what we try to do. 2 So it's an interesting concept. The goodwill's also 3 a very interesting concept to me because we've talked about 4 enterprise goodwill, we haven't talked about segment goodwill. 5 And segment goodwill is an even more interesting concept because 6 when you get down to the segments, you may have bought a company 7 and you've segmented the goodwill. And then as the company goes 8 on and evolves, you may decide to not invest as much in one 9 segment as another segment. Because the goodwill is actually 10 covered by the future. 11 When you do that, you potentially have an impairment. 12 So it's very interesting to see how this all works. 13 And I can understand because even when I look at that and I say, 14 but that doesn't make any sense because as an enterprise you're 15 - you're building the enterprise, but somehow I have a goodwill 16 impairment on a segment. So does - does that - you know, it 17 doesn't ring true to me. 18 So even as a preparer, it doesn't ring true to me 19 but that's the accounting rules that are out there and that's 20 what we have to live with. 21 MR. PENMAN: I guess the empirical question is where 22 the allocation of purchase price, the goodwill purchase 23 intangible fair value, actually means anything actually; whether 24 we're doing anything. Particularly between purchase intangibles 25 and the goodwill. 0039 1 MR. KABURECK: Let me just share a conversation I 2 had with a private banker about a month or so ago. She was a 3 major money center bank but did private lending, you know, as 4 opposed to comm - public company lending. We had a four-hour 5 layover with flight delays. And so I'm reading something from 6 FSAC or ATF or something and she starts talking to me. 7 So we got into - and this went on for an hour almost 8 about the most important things to her is an investor where 9 understanding the company's business model, understanding how 10 well management understood it's business model and how much 11 confidence they have in management as being quality management. 12 She says, everything else is minor. At least in this person's 13 mind. 14 I'm just sharing that with you for what it's worth. 15 The other thing, I think - and this probably more 16 impact to the FASB and - for as long as I can remember, it was 17 -- good disclosure is not a substitute for recognition. And 18 I'm wondering is it time, perhaps, to revisit that? Because 19 there's a lot of things valued at fair value that you're never 20 going to get the fair value. 21 I remember the very first financial instruments 22 roundtable we had here in this building five years ago and how 23 Schroeder, FASBI and I were on the same panel. We had something 24 of a spirited debate: should company's long term debt be marked 25 market or not. It said, it makes no sense. We - you know, 0040 1 these are - I mean, this is a capitalization of company. It is 2 intended to be held to maturity. I don't mind a footnote 3 disclosure and we went back and forth on it. But it got me 4 thinking, this was almost five years ago. Is the - should 5 disclosure actually be a substitute for recognition at some 6 point? 7 Should we revisit that, I'll call it "conventional 8 wisdom," or as long as I can remember, founding thing, because 9 going back to what Professor Penman said, people want 10 consistency. They want objectivity. And leave - and leave the 11 speculation to us. Well, that would seem more - maybe something 12 should be perhaps more in the footnotes going forward then 13 actually recognized and measured on the face of the statements. 14 So its sort of a long-term, you know, thought I'm 15 putting on the table. Obviously, that's not something we can 16 operationalize quickly. 17 MR. SURI: Absolutely. Couldn't agree with you 18 more. 19 I think one of the things that we need is truth in 20 labeling. Fair value is neither fair nor a value. That's the 21 first thing. 22 (Laughter) 23 MR. SURI: So, you know, we need to get that on the 24 table. Get comfortable with that. The earth's not going to 25 shatter. And these items should be moved into disclosure. 0041 1 These are additional add-ons that are useful to assess what 2 management is viewing. 3 The most important thing - I cover insurance 4 companies - I am hard pressed to think of an industry where 5 there's more estimates thrown in that are long tailed and highly 6 uncertain, fully exposed to macro-economic variables. And it's 7 a bit like driving in a car without any doors, windows or walls. 8 You wouldn't do that. And when you put the statement's primary 9 measurements of an insurance companies exposed to the market 10 vicissitudes all you're doing is forcing investors to go back 11 and unwind that. And I guarantee you none of us can ever do it 12 right. 13 We're - we're not equipped. And to look today at 14 evidence as to where insurance companies and how they're being 15 valued, the fair value is what's being excluded; EPS estimates; 16 price to book estimates. I look at equity valuation models. 17 Show me an equity valuation model that doesn't require clean 18 surplus. This concept of OCI has been one of -- I think it has 19 become a dumping ground. And as we hear more and more about the 20 new proposals that are coming in, there's more fair more value 21 inserted. And then the offset of that is, well, it will be an 22 income statement so lets dump it in OCI. No. Because there are 23 many of us that do look at the balance sheet. And when you look 24 at the balance sheet and you look at OCI, that just beginning to 25 look more and more like a crash dump. 0042 1 I think that's something that needs to change. If 2 it doesn't belong in earnings, it doesn't belong in OCI. It 3 should go into the footnotes, and it's very useful as an add-on 4 to see here's what management is viewing. Are they credible? 5 And here's what the market is viewing. You know. Market is not 6 always right. And I think we need to stop giving too much 7 credit to these concepts. 8 And level three versus level one, it's irrelevant. 9 And if you look at insurance companies, everything they have on 10 their balance sheet is level three. I mean you're - you're - 11 you're paying management to deploy capital as a financial 12 institution. So that's what you're buying into; their ability 13 to deploy capital better than anybody else. So level one, 14 two or three, I think it was a helpful idea between FAS 15 157 and 159 but - and when we look at the disclosures today, 16 20, 30, 40, 50 pages, and I can't reconcile any of those tables 17 to what's in the balance sheet, it's just - and it's more 18 quantity and no quality. And I think that's something that, you 19 know, we need to be cognizant of as well. Because people start 20 chewing things out. 21 MR. SIEFERS: If I can take a quick second. Pinto 22 brought up some really good points. I just wanted to shift it a 23 little to the - to the bank side just as an example. And we got 24 this notion of fair value comment. And, you know, to a certain 25 extent there's a push to increase fair value accounting in bank 0043 1 income statements, for example; a loan portfolio, which is by 2 far the largest asset class. You know, if I look at the 3 introduction of greater fair value into a bank income statement, 4 you know, what it would suggest is every 90 days we'd have these 5 enormous swings in bank income statements simply because, you 6 know, we'd effectively be having to manage two 90-day swings in 7 interest rates. 8 Just take the last month or so, the tenure has moved 9 about forty basis points or so. I can guarantee no bank 10 management is managing it's own balance sheet for that - that 90 11 day swing in rates. But, I know if it were to start getting to 12 be incorporated into income statements, all we would really do 13 is, you know, introduce a heck of a lot more volatility and 14 probably a lot less confidence into - you know, it's kind of the 15 integrity of those statements as well. 16 So I thought Pinto made some really - really good 17 points there. 18 MR. SURI: I would actually submit that if you look 19 at the insurance industry today, you're already seeing that. 20 You're already seeing what banks will look like. And just think 21 about the fact that if we think about financial intermediation, 22 the two main segments are insurance and banks. You know, I 23 think if - if we start - and both of these tend to be longer 24 term. So you know inherently that you're not writing a loan to 25 go sell it in the market tomorrow. 0044 1 And we've already had FAS 107, fair value 2 disclosures. Nobody uses them, because they're not important 3 for investment purposes. We're not concerned about what the 4 value is today alone. It is where do we think this will land up 5 three years, four years, five years down the road? 6 I think as you're looking at standard setting, as 7 you're looking at regulation, it's really critical that you also 8 give some thought to what the implications are and what the 9 consequences will be for capital allocation. Because if you 10 move to, for example, where the ISB sets today for insurance 11 contract proposal, the sector, I think, has already been set by 12 others before me, is uninvestable. It's simply uninvestible. I 13 think that should be, you know, a big wake-up call. The largest 14 bond buyer globally in corporate credit, capital moves away from 15 that, what does that mean for the rest of the capital markets? 16 MR. LITKE: I think to some extent we're over 17 simplifying a little. Investors want as much, I think - and you 18 said it - as much certainly in the numbers that get reported as 19 possible. But sometimes the numbers really aren't certain. 20 So when you take the insurance example, if 21 somebody's issuing variable annuity contracts, very long tail 22 liabilities, the fact of the matter is, if insurance company A 23 and insurance company B issue a comparable contract, it should 24 have the same value on both person's balance sheets. 25 Essentially, they're exposed to whatever the long term interest 0045 1 rates are and the long-term volatility. 2 But you - you can't put the risk disclosure into the 3 numbers. You might put some sensitivities into the numbers, but 4 ultimately you've got to get some risk disclosure around these 5 numbers. I think your question about DVA was a - DVA came in as 6 an attempt to impose a false consistency. You know, you wanted 7 somebody who issued a bond and somebody who bought a bond. You 8 wanted it to add up to the value of the bond. 9 But it's - it's - it's not. That's only true in - 10 it's not two different people's balance sheets. So the sum of 11 all the balance sheets doesn't necessarily add. And we're 12 trying to make things add up that don't always add. 13 MR. SURI: I think increasingly what accounting is 14 doing is, you know - it appears to be - I'll put it candidly - 15 naive application of basic theory. And it ignores certain basic 16 tenants from economic theory to justify how these things show up 17 in primary measurements. 18 And the issue is not that there shouldn't be fair 19 value. The issue is, where does it belong. It does not belong 20 in primary measurements. That's the bottom line. 21 MR. KROEKER: I heard you say earlier it does in 22 some cases, at least, you thought that for investment - you 23 know, where you're trading - you know, as you're trading - 24 MR. SURI: Sorry. I just want - 25 MR. KROEKER: - spent a lot of time in the crisis 0046 1 dealing with - 2 MR. SURI: Absolutely. 3 MR. KROEKER: - with the role of fair value. I 4 heard from an awful lot of investors is, well, they took 5 confidence when you've got trading activities, things like 6 derivatives where there's not an anchor absent. Some type of 7 estimate. If you went to a cost model for derivatives, you'd 8 have something that was zero at inception and swung wildly in 9 terms of its economics. 10 MR. SURI: But I think what is also important is, 11 how - how do we define what a derivative is. If I take a 12 guaranteed living benefit and define that as a derivative, you 13 know, that creates a whole lot of problems for investors. And 14 what it does is, at the end of the day, it imposes an 15 exceptional discount on insurance companies that issue that 16 product. 17 So if as standard setters and regulators we decide 18 that, you know, you're - you're - you want to take things in a 19 different direction, you can, but at the end of the day, if 20 you're changing - you're forcing a company to change the 21 business model because of the regulation or the reporting of it, 22 I think somehow that - that doesn't quite sit right. 23 I think - I think the business model should be 24 prominent in how these standards are developed. 25 MR. PENMAN: Yes, that's correct on fair value. 0047 1 It's talking business. I mean, if - I don't think we'd disagree 2 that a hedge fund should be fair value, okay. The holding - the 3 holding - the holding assets -- that the outcome's dependent on 4 the fluctuation of market prices. Okay? It's just investment 5 fund. And that seems a very clear case of fair value 6 accounting. It's the one to one principle, okay. The price 7 goes up five dollar, your wealth goes up five dollar. 8 For an organization whose wealth comes from trading 9 with customers, it doesn't seem right. I mean, if - if - if it 10 comes from customer relations, your productive technology, it's 11 any - any business where the top line is revenues to pretend 12 that you're going to actually get the accounting right by 13 marking the balance sheet to market, doesn't seem - it's not - 14 it's - if you're - you're a speculator holding coal, you 15 speculate in coal, okay, and you just - the price goes up and 16 down, you bought it market to market because you're trading 17 coal. You're a commodity trader. But if you don't got a pile 18 of coal sitting - a pile of coal that's sitting there to go in a 19 vast furnace to make steal. The fact the price has gone up, 20 it's not - it's not appropriate to have fair value accounting 21 there. 22 I think that's - that's sort of an important 23 principle; to separate the trading portfolio from the bank's - 24 the bank's business portfolio. 25 MR. KROEKER: Marc and Chairman Doty, feel free to 0048 1 moderate and step in whenever you want. You don't need to look 2 to be called upon. 3 (Laughter) 4 MR. SIEGEL: Jim, can I ask one question? No. 5 Well, I will. 6 I guess - I guess - it's interesting the 7 conversation has - has become one, not surprisingly, of fair 8 value versus cost. And I want to get back to a little bit of 9 even in the cost environment there is certainly management 10 uncertainty. And - and I really want to get at what are some of 11 the thoughts around there. Because, you know, the - I - I - 12 some of us have a little bit of a problem with business model 13 being the sole determinant because, as - as Adam pointed out 14 earlier when he was looking at Wells and Wachovia, the same 15 asset in the portfolio is - is being marked - is - is being held 16 at two different measurement attributes. And that doesn't make 17 sense. 18 But yet when I hear Stephen talk, he was saying that 19 if a hedge fund held a, you know -- a loan book that should be - 20 that should be marked, but at the same - if a bank held the same 21 asset, that should be at cost because that's the business model. 22 And that's - seems like it's a tough trade-off when 23 you're talking about the same asset should it always be. And I 24 understand. 25 The FASB has in 2009 proposed more fair value for - 0049 1 for loans since then and - and we got lots of feedback similar 2 to today and the FASB is no longer looking to mark loans on the 3 balance sheets so that should be off the table. 4 The FASB is not looking to mark deposits to the - on 5 the balance sheet, and that should be off the table. It was 6 actually never trying to - correct something that was said 7 earlier -- it was never trying to book a customer deposit 8 intangible on the balance sheet. That was actually explicitly 9 excluded. 10 But in a cost measurement so today loans are at 11 cost. And you have to estimate a credit impairment for those 12 loans. That is an uncertainty. That's a measurement 13 uncertainty. It's a cost you have to have a -- what's going to 14 be the loan impairment. 15 The FASBs rules about the incurred loss model, 16 waiting until it's certain that you have not gotten a default - 17 you have gotten a default on a loan, that's when a loss is 18 incurred. And the - and the FASB was criticized soundly for not 19 booking losses in a timely basis. 20 And the FASB is now trying to understand when to 21 book those credit losses. And I'd love to get some feedback on 22 that, because that is not a fair value. That's a cost 23 environment. What is the information set that we should be 24 looking at? What are the uncertainties and what information do 25 you need as investors to try to get your arms around that 0050 1 measurement uncertainty? 2 MS. DOPKIN: I think it goes to, like, okay, so how 3 much rainy day reserves are you going to let, you know, an 4 individual company build up? I mean, the problem - the problem 5 reserving for banks and even reserving for insurance companies 6 is that in the good times they constantly under - hold back and 7 then in bad times, they're - they're playing this catch-up game. 8 Then when they need to go raise capital, they can't raise - 9 they can't raise capital. I think in the standards that were 10 trying to be laid out, because it was like a year ago, you know, 11 to the extent that, you know - and even with our firm there was 12 various opinions as to, like, how much provisioning should a 13 company be able to do. And is it - should they be able to 14 provisions for around the corner versus around two years because 15 you know cyclically loans are going to have a certain type of 16 charge rate and, again, our firm has various opinions. 17 But today it just seems that there isn't enough 18 flexibility to reserve enough up front. And it kind of goes 19 back to when Suntrust, like years ago, they got sued for - or 20 whatever, had to do a settlement. And that's what banks use all 21 the time. I can't - I can't put up enough reserves because they 22 go back to, it's not - I don't know whether there's going to be 23 a loss. I don't see a loss six months from now. 24 But you know cyclically if you go back and you look 25 at what your book is and how much your losses are on average, I 0051 1 think there should be a better ability to smooth the provisions 2 over time. 3 MR. SIEFERS: Excellent point. I mean, as somebody 4 who's covered bank stocks for the last 10 to 15 years, that 5 SunTrust example that you brought up, which was, I think, from 6 '98, that reeked enormous havoc on both the bank earnings and 7 capital - capital dynamics in that I think SunTrust for the last 8 - or that decision, I should say, for now the better part of the 9 last 15 years has been used as the backstop for why - why we 10 have this pro-cyclicality in the banking space at least. 11 You know, basically, we went through call it '03 to 12 '07, we went into the financial crisis with the least amount of 13 reserves that we had had in history, basically. So what that 14 lead to was everybody needed to be - felt their reserves at a 15 time when the stocks were decimated. Couldn't get capital and 16 they needed it. 17 So, you know, that is - is one area where I would 18 love to see a little more flexibility in terms of reserving. I 19 think probably the best thing I ever heard is completely 20 unrealistic, but, you know, get rid of reserves altogether and 21 add 200 basis points to bank capital ratios. Now, to a certain 22 extent, actually, Basal three has taken care of that for us. 23 But, you know, just to the extent that we could maybe keep a 24 little more flexibility in reservement policies, that would be 25 great. 0052 1 And I wanted to quickly tie this into something that 2 Adam had said earlier just on valuing assets differently within 3 - within a bank. 4 I'm not sure if you meant to, but that fair value 5 argument and taking credit impairments at the time of a merger 6 had - you know, there have been some really significant 7 ramifications. I guess the way I think about things, for 8 example, a loan is generally pretty liquid. So, you know, from 9 the investors standpoint, the last thing that you have to go on 10 is the last mark. 11 So what that encourages in bank M&A activity is a 12 bit of a vicious cycle in that, you know, a second mark, for 13 example, if there's been deal a, deal's b mark is not considered 14 credible unless it's at least as conservative or punitive as - 15 as the first mark. 16 So I'd - I'd point to at least - this is sort of an 17 extreme set of example, but it - it had ramifications in the 18 financial crisis. 19 For example, when J.P. Morgan bought WAMU out of 20 receivership they took big marks on that WAMU portfolio. The 21 first thing people did the next morning was take those - put 22 those same marks onto Wachovia's balance sheet. You know, then 23 Citi and Wells Fargo both -- both, you know, made bids for 24 Wachovia, after it was effectively run on that bank and were 25 even bigger than the WAMU marks. And, you know, a month later 0053 1 there was no National City, which PNC gobbled up. 2 So it can be really, really tough and have real 3 ramifications, particularly during times of crisis. So just an 4 additional thought. 5 MR. PENMAN: But - but I think back to my earlier 6 point, there's two ways. The loan loss reserving is a big 7 problem. And one way of handling it is - is to book the revenue 8 and then say, well, maybe I'm not going to get it. Okay. And 9 sort of write it down. 10 The alternative would be, don't book them til you're 11 really sure you got it. Okay? Which should be the conservative 12 way of doing it. 13 So really when - when the customers got -- when the 14 mortgage - let me back up -- equity in their home, credit 15 worthiness has been established, then - then I book it and then 16 I amortize it in and I amortize it in slowly. That's another 17 way of handling it. 18 So the onus is not - not on the presuming they're 19 going to - you've got it and then worrying you haven't got it, 20 but actually making sure you got it. 21 MR. KROEKER: So that's a really difficult one when 22 I think about it, because there might be some loans where even 23 that isn't enough if it becomes evident at some point that the 24 individual isn't going to pay so now you have an asset at 25 hundred and if it becomes apparent, you know, and then you - 0054 1 you've picked a level of uncertainty, around apparent that the 2 person is not going to pay. Since we would hear vocally from 3 investors if we continued to carry those at a hundred. And I 4 think that's the challenge that FASB's facing right now with 5 saying we should be more forward-looking on provisioning, which 6 sounds like incorporate some increase level of uncertainty as 7 opposed to waiting, as we do today, until a loan loss is 8 probable. 9 MR. LITKE: One thing you might do if you're looking 10 at provision loans, look at the way people do insurance but 11 don't copy it exactly, which is to say, when I make the loan, I 12 have a pretty good idea what the expected losses are, not on the 13 individual loan but on my loan portfolio, even if it's a bunch 14 of consumer loans or a bunch of small business loans. Have a 15 good idea what they're going to be over the life of the loans. 16 That's going to move up and down. 17 There's no particular reason not to allow reserves 18 when I believe that the losses over the remaining life of the 19 portfolio are going to be higher than the income over the 20 remaining life of the portfolio. You're not being aggressive in 21 allowing extra income but now you've allowed some long term 22 estimate of future losses to come into your provisioning before 23 you actually have to wait until the loss happens. And nothing 24 wrong with that. 25 MR. SURI: You know, the existence of a loan loss 0055 1 reserve, what that's saying to me as an investor is, there's 2 uncertainty in the revenue stream. I mean, that's - and the 3 degree of uncertainty you can measure because you've got the 4 disclosures, you've got the loan stats. 5 I think it all comes back to how much disclosure and 6 then - specifically, I think Marc your question about incurred 7 versus expected. It should be expected. When you issue a loan, 8 you have some expectation that there may be a loss. Perhaps 9 maybe you have some expectation there's no loss. That's fine. 10 But as long as there's some disclosure around either that loan 11 book, portfolio, or by specific categories of loans, I think 12 that allows us to then dig deeper and have that discussion and 13 be able to make those adjustments. 14 I think that definitely is more helpful than the 15 current incurred loss model. I think the PNC insurance, you 16 know, certainly more so than life, would be - would be 17 instructive. 18 MR. KROEKER: This certainly doesn't have to just be 19 - it wasn't intended to be necessarily about loan accounting. I 20 think it's demonstrative of - of the issue but we see it in 21 other places where I think it's equally as challenging really on 22 both sides. The FASB issued guidance on accounting for 23 uncertain tax positions, so those are things that there is some 24 inherent level of estimate in the future as to what the ultimate 25 outcome might be on a tax uncertainty. 0056 1 And, of course, they responded there because absent 2 that guidance, I think people were defaulting to a more general 3 level of reserving that wasn't necessarily meeting, I guess, the 4 three criteria I heard at the outset of transparency, 5 objectivity and comparability. But that's another area where 6 now people are being asked to take things that could really 7 range the spectrum from those things that I could estimate with 8 some degree of precision to those that might be fairly 9 speculative until - in terms of the final outcome. 10 So I think it isn't just necessarily about loans. 11 MR. PENMAN: In the write-up you sent us you 12 referred FAS 5, okay. They only book them as probable and can 13 be reasonably estimated. And the other model, of course, is the 14 fair value model you estimate. Okay. And that's a good 15 intention, which way you want to go. I tend to like the FAS 5 16 model myself. I need a balance sheet when, you know, I actually 17 got some hard numbers there. I had to put an estimate on of a 18 low probability law suit, okay. And then change that estimated 19 period, you really screw up my income statement because all this 20 has changed the estimates. 21 That doesn't mean - of course, you don't want 22 disclosure with it if possible or remotely possible, whatever it 23 is. 24 But I think that's a good - that's a good - that's a 25 good - good intention there. Whether you want FAS 5 criteria or 0057 1 you want to do estimates of probabilities. 2 MR. KABURECK: Jim, I would think one of the ways to 3 wrestle the question is, when is a bad estimate being disclosed? 4 Recognize or disclosed, this case would be better than - I 5 mean, is - there's - there's degrees of reliability, you know, 6 which eventually become degrees of unreliability as you try to 7 deal with the unknown or contingencies or uncertainties. And I 8 think there's a general view that within some pretty wide 9 tolerable limits, and bad estimates are the no estimate. 10 I think that sort of conventional wisdom and maybe 11 it's not a hundred percent shared, but I think it's broadly out 12 there. And you might want to revisit the question; what are the 13 tolerable limits of disclosing estimates when you have 14 management, or whoever the preparer is, has zero confidence in 15 them as having any degree of probability in them. 16 And, again, I'm not suggesting how you answer the 17 question. I think it's a fair question about the limits of 18 disclosed estimates. 19 And the only other point I would make on that is - 20 and I think this is true a couple of times - you might have 21 very sophisticated financial models, actuaries predict 60 years 22 to the penny, but ultimately they're probably premised on a 23 couple of very simple, high-level assumptions, whether it's a 24 goodwill recovery. You know, earnings will go three percent. 25 That's a high level assumption projected out ad nauseum but most 0058 1 estimates are probably are grounded on two or three very simple 2 high-level assumptions. And let's not pretend facts on the 3 company spreadsheet that it actually is really precise. 4 MR. KROEKER: I take it when you say, "bad 5 estimate," you mean imprecise not - 6 (Laughter) 7 MR. KABURECK: A well-intended, highly imprecise 8 where many experts could widely differ on what it is on the 9 various estimate. 10 MS. CANGIALOSI: Yeah, I mean I would - I would echo 11 that and I think, again, here what I'm hearing from - from a lot 12 of the people, if I'm interpreting it correctly, is when you're 13 dealing with things that have a shorter term horizon, estimates 14 seem more appropriate, because you can get much more precision, 15 if not precision, you have a better view or a better window into 16 the future. 17 When you come up with very long-term things or 18 things that have maybe 20 variables in them, it gets a lot 19 harder to come up with an estimate. And it certainly would be a 20 lot harder for the - the folks in the investing community to 21 figure out an estimate because you'd have to know how to deal 22 with all those things. 23 I - I do think, you know - and I loathe to say 24 contingencies, in particularly litigation is one of those areas 25 where we see that all the time where you've got human elements 0059 1 that are unpredictable. You have judges. You have plaintiffs. 2 You might have hundreds of cases or thousands of cases. And 3 they're in different jurisdictions. They're with different 4 judges. They come up with different outcomes. You know, Bell 5 Weather cases are - may or may not really be Bell Weather 6 cases. They're hand-picked, supposedly to show something, but 7 people disagree on that. 8 So it's very difficult, even with time, because you 9 get to things like discovery. Does everybody understand what 10 discovery is? How - how quickly does it happen? Why does it 11 take so long? What are the - the facts - are there real facts 12 behind it? Is it a novel theory that somebody's trying to try? 13 So how do you take all these elements and come up 14 with an estimate and I think how would you audit them, because 15 it's as equally as difficult to come up with the estimate as it 16 is to audit those kinds of things. 17 So I think, you know, where we have less 18 speculation, estimates are a good thing. Where they're highly 19 speculative, I think that's where, you know, it's - it becomes a 20 lot more difficult as to - certainly putting them in the 21 financial statements, to me doesn't make a lot of sense. 22 Whether or not you can disclose them - I mean, I 23 would be loathe to disclose an estimate, as Gary said, that I 24 had no confidence in just because I had to do it. So - 25 MR. KABORECK: I think however you bring this - 0060 1 however you and your colleagues bring this forward, litigation 2 would not be the subject of choice I would pick. There's a lot 3 of lawyers in the room and, I mean, you got all the 4 attorney-client plus you put a back - the very highest out 5 there, might become self-fulfilling. I would focus on the 6 operational assets and operational liabilities that management 7 sort of works with day to day. And that's sort of a special 8 case the litigation. 9 MR. DOTY: I've been sitting here, as a lawyer 10 should, keeping accounting principles and auditing separate - 11 trying to keep that separate in my mind. And whenever I start 12 talking about this, I know that the stomach begins to turn from 13 Martin Bauman and Jay Hanson because they're not sure that I can 14 actually keep it straight. 15 But we, of course, are interested in what 16 investors want to know in terms of considering the audit 17 reporting model and considering other transparency and 18 objectivity initiatives we have. 19 I was particularly struck by what Jennifer Paquette 20 said in this regard, because I suppose we recognize - we're 21 recognizing it inherently in the discussion the distinction 22 between the disclosure and attestation. I'm not sure, though, 23 that Pinto and others are really trying to rollback the "C" on 24 fair market value or whether that's practical in the area of 25 inclusion of - of amounts in the balance sheet. 0061 1 Therefore, it seems to me, we -- we would be 2 particularly interested in knowing how investors react to the - 3 to the emphasis we have put on it, which is trying to make sure 4 that auditors understand and get behind the variances in terms 5 of valuations that are placed on intangible estimates. 6 We have a task force going to look at - at 7 valuation. How much can be said in the audit report about the 8 range -- recognizing, in other words, that the audit is not 9 exact. How much can and should be said in the audit report to 10 recognize the range of of possible estimates and how the 11 estimate or how the valuation that management puts on a 12 financial instrument was arrived at. And if, in fact, more is 13 done in that regard, are you - are you more comfortable with the 14 uncertainty if you know how - more about how the management got 15 there; if you know more about that from the management and/or 16 the auditor. And does that reduce - it may not effect the 17 volatility. The volatility may - may still be there. But does 18 that change your view about the ability to live with 19 non-comparability? 20 MS. PAQUETTE: I think enhancements to what we hear 21 from auditors in financial reporting are worthy of pursuit. 22 When I listen to challenges in how to account for 23 things that are uncertain, I'm in an area that I'm not an expert 24 in. I'm - I'm an investor as opposed to an auditor or an 25 accountant, and I'm respectful of what those challenges are as I 0062 1 hear them here this morning. 2 From - from my perspective, I imagine that we're 3 looking for things that are of significance and material. And 4 I'm not using that in an precise sense. But executive teams of 5 corporations will assess their businesses and they will assess 6 estimations and they will make decisions on what they pursue for 7 their businesses in the future. 8 I think what investors are looking for is a better 9 understanding of what those assessments are and what variables 10 were used to make judgements when it comes to valuation. 11 Colorado Para along with other investors have 12 expressed support for this notion of hearing from auditors on 13 where were significant estimates made that perhaps they were 14 allowable by gap accounting, but they weren't, perhaps, the most 15 used or best practices. And understanding -- and having a 16 discussion of what those measures were. And perhaps they're 17 very good justifiable reasons why a different model and numbers 18 were used, but understanding what they - they were. 19 I'd like to think that from an investor perspective, 20 we're trying to be pragmatic and not ask for the world and ask 21 for the data that we can't use. That isn't going to help us 22 analyze how a company may perform in the future. 23 But I do get a little frustrated if - if the 24 response after 2008 is we can't, it's hard, it may not be 25 relevant, it may not be helpful. I think if we try and get some 0063 1 of the larger categories that influence results of companies and 2 get better disclosures in those areas, I think we would all be 3 well served. 4 MR. SURI: The only thing I would add to that - I'd 5 agree. I think something along the lines of an exception 6 report, if you will, where you have some disagreements. There 7 has been some gray areas. You know, there's - there's a recent 8 case in the last few weeks alone where something like that from 9 the auditing side perhaps could have been - could have led to 10 some questions. 11 You know, if we go back having kind of survived 12 through the crisis, I'd say an auditor expanded DNA as cold 13 comfort when things go wrong. I can't that to an investment 14 committee and say, well, you know, the auditor said this. It 15 doesn't work. 16 So at the end of the day, the financial statements 17 are already being certified by the management team. And the 18 question then becomes, how many more people need to certify 19 these statements. And are we going to have longer lists of 20 signatures than we do statements? 21 At some point we have to cut that. I think an 22 exception report, a brief bullet point, even, of issues would be 23 helpful. 24 MR. SIEFERS: I think just to - to react to to your 25 initial question here. 0064 1 I think to the extent that the companies we're 2 discussing, the market will ultimately determine how aggressive 3 or conservative it believes any individual management team is. 4 You know, I think Gary had noted earlier just the concept of 5 business model. When I heard some of his comments, you know, I 6 took - I took that to sort of mean, you know, differentiated 7 factors that - that people will look for in individual 8 companies. 9 You know, I think over time, you know, if you get 10 the background of, you know, items that went into any individual 11 assumption, I think that's fine. Over time, the market will - 12 will judge whether those are - are conservative or aggressive 13 and, you know, rationalize those companies that it - it deems to 14 be too aggressive. 15 You know, I think it's practically something like 90 16 percent of the S&P 500 rolls over every 50 years, right. So, 17 you know, at the end of the day, that's - that's kind of how the 18 market and capitalism ultimately works. 19 So, yeah, you know, to get a sense for better 20 background of, hey, here's - here are the x, y, and z reasons 21 that are making a certain decision or a certain assumption, you 22 know, is certainly helpful and then ultimately the market will - 23 will - will judge it. 24 MS. CROSS: So listening to this conversation I 25 can't - since I'm not an accountant - the current rules require 0065 1 MD&A disclosure about known trend events on certainties that are 2 reasonably likely to make future results and the financial 3 condition not look like what you have today. And we have the 4 critical accounting estimates disclosures. We had the 5 prescriptive rule proposal, which was not adopted, but we 6 continue to have the disclosures about critical accounting 7 estimates. And in my prior life, I helped companies craft 8 those. 9 It feels a bit like we're trying to solve for 10 something where we already have requirements for these 11 disclosures where, because of the accounting decisions are so 12 difficult, we default to more disclosures. And so we end up 13 with just redundant disclosures all over the place. You know, 14 the risk factors have one level of disclosures. MB&A has one 15 level of disclosures, critical accounting estimates and then you 16 get into the footnotes and they become completely unmanageable 17 in length and duplicative of the filing. 18 And I'm struggling very much with the complaint I 19 hear constantly from the corporate community, which is we just 20 keep adding requirements for more and more and more disclosure. 21 And there's - life is simply uncertain. There - there are - we 22 can't measure everything and we can't provide certainty about 23 everything. 24 So is there - is there something to be done where 25 you can marry up all these different requirements in a way that 0066 1 doesn't result - are the critical requirements in MB&A and 2 elsewhere just not worthwhile and so people are not - they're 3 not written right or people don't provide the right disclosures 4 because they're not subject to audit? Or - I'm struggling a bit 5 with how - how do we - how do we address that problem without 6 just adding more disclosures and recognizing that - that we 7 can't make things certain that are uncertain? 8 MR. SURI: If I may. You know, there's a recent 9 transaction that has lead to some serious problems for a 10 broker-dealer. And when you look at the transaction, getting 11 sale classification was perfectly within limits under the gap. 12 But when you look at the substance in the transaction, clearly 13 it was not a sale. And I think in instances like that where an 14 auditor presumably is already 15 having those discussions with management, at least having some 16 sort of a hint or a question of saying, this is where we 17 disagree. It doesn't have to have details on that transaction, 18 but at least it gives investors an idea. Because when we're 19 looking at the financial statements, there was no evidence that 20 such an - you know, of such an assumption had been made. 21 And having some sort of insight, okay, that there - 22 there are some concerns or there's been some more discussion 23 around this, that - that's really - I think that's more the 24 exception than across all aspects. 25 MR. PENMAN: Yeah. Mr. Doty, what about the 0067 1 requirement from your Board when the auditors actually see a 2 firm conforming to GAAP but it's formed of substance? They 3 actually have to have a conversation with the audit committee 4 and point it out to them. You know, this is transaction 5 retrievals. And it's - so it would be good if the auditor would 6 - actually were required to have a conversation with the audit 7 committee saying, look, yes, it's consistent with GAAP. I mean, 8 there's all sorts of screens in the structural engineering 9 business to to get around GAAP, to get a presentation. The 10 auditor is required to actually make a judgement as to whether 11 this is formed of substance and then have a discussion with the 12 chair of the audit committee. 13 MR. DOTY: Well, without commenting on any case that 14 may be in the news now and having regard for Meredith's valid 15 question of when do the actual textual non-financial disclosures 16 become so overwhelming. The statute clearly does require 17 conversations with the audit committee when there are preferred 18 principles of accounting. 19 We have a proposal out, which I think will be, 20 again, refreshed, on communications with audit committees. One 21 of the things the Board is very concerned about is that we 22 enhance and foster better communication with audit committees on 23 a range of subjects without - without taking away from or 24 sapping the ability of the audit committee to maintain the 25 effectiveness of that dialogue in the board room. 0068 1 It's a very real issue. And one of the lessons that 2 came out of the financial crisis, I think, loud and clear for 3 us, in addition to the difficulty of dealing with the 4 estimations, was that investors felt that there should have been 5 a lot of robust discussion with the audit committee. 6 In some cases, probably clear that happened. And in 7 some cases, not so clear. There's a range of talent and of 8 activity level on audit committees. So all of that is, I think, 9 very much in the mind of - of the Public Accounting Oversight 10 Board right now and it will be - it's something we'll be wanting 11 comment on from all of you. 12 MS. DOPKIN: You know, I think it - you know, the 13 things that we're looking for are the hidden leverage rate. In 14 that particular case, there was much more leverage than was 15 stated. When it comes to, you know, the operating leases that's 16 taken kind of forever to maybe fix the accounting. The 17 information is there to investors to back it up. The rating 18 agency is - it's really transparent as to what's happening, you 19 know, with potential leverage from the operating leases. 20 So in this case whether it's a sale or not a sale, 21 it's the spirit - form over substance. And if it's really a - 22 if it's not really a sale, then something in there, you know, to 23 investors, "Hey, the leverage really isn't 5x it's 35x," is 24 quite important. 25 And then the second thing that is frustrating for 0069 1 investors is misguided comfort when companies disclose much 2 smaller net numbers. And they don't really - you know, there's 3 a lot of - you know, too big analysis to - why do we need to 4 show all this, you know, all this - all these big gross numbers, 5 what you really care about investor is net. Well, two net 6 numbers are not necessarily identical if one of them came from 7 coverage from a better credit party than another. And that 8 information at this point is just not transparent to the 9 investor. 10 And given what we went through in the last crisis, I 11 don't really think it's that unreasonable to give information to 12 investors with a little more clarity, how you're getting to the 13 net number. It's not giving every single number, but enough 14 information that you have a sense for, are there credit-worthy 15 counter-parties behind the gross to get to the net. And that 16 information is just not there. And it's just as bad as hitting 17 leverage of things that are really not a sale when they're 18 deemed a sale. 19 MR. SURI: I couldn't support that more. I think 20 the gross versus net had been - if I go back to 2007 through 21 2010, it was worse than pulling teeth without anesthesia. They 22 just - they would not disclose it. And I think, you know, 23 what's a Greek CDS worth today? You know. If you just report 24 me net numbers, it says nothing. If we look even today, it's 25 net numbers being reported and then 0070 1 you're having these, you know, contentious arguments. 2 MR. KROEKER: So to be clear, in the gross versus 3 net, are we talking about derivative - principle derivative 4 exposure where you have derivative assets and derivative 5 liabilities and they're being combined because they might be 6 settled under master netting arrangements? Is that - 7 MR. SURI: Yes. Absolutely. 8 MR. KROEKER: Okay. I just wanted to make sure when 9 you say, "net exposures," that - that's - that's what we were 10 focusing on. 11 MR. SURI: But even - even, for example, with a lot 12 of MBS holdings for financial institutions, a lot of them were 13 reporting them net. We've got hedges against us. Well, hedges 14 from who? Right. And from entities that we already have 15 concerns about, as you find out after. 16 I think those are the concerns that the gross 17 numbers breaking out of who the counter parties are. 18 MR. LITKE: I think there's - I mean, having - 19 having sat through having to prepare some of these numbers and 20 even get risk committees and Forbes to understand them, you're - 21 you can have that kind of disclosure when you're in the middle 22 of the crisis because you know what you're worried about. But 23 if you talk about somebody's entire counter-party book and they 24 have thousands of counter parts, you don't know which particular 25 asset class is going to be the one that's a problem two years 0071 1 from now. 2 And, you know, you mentioned hedge funds. Most 3 hedge fund transactions are collateralized. So, in fact, 4 they're not really the worse the counter-parties in the world. 5 The worst counter-parties in the world are the people who don't 6 post collateral. 7 And - and - and the problem becomes how do you 8 distill it? So I think that's something - it - it can be very 9 hard - gross versus net is something reasonable to put in the 10 financial statement because it is an indication of the total 11 amount of risk but if you want to start disclosing the 12 counter-parties or the types of counter-parties and whether you 13 have wrong way risks, I think that's something that has to be in 14 the discussion. I don't know how you'd put that in the 15 statements in a way that was consistent from quarter to quarter. 16 MS. SURI: Actually, it's not a question of in the 17 primary. I think this is about disclosure. And I wouldn't see 18 why that would be an issue because insurance companies provide 19 that under the insurance side. 20 So, you know, you can see the top 20 counter-parties 21 on the insurance book. I mean, that's pretty much standard 22 disclosure on the P&C side. So being able to disclose 23 counter-parties, I think, particularly ones that are 24 significant, you know, maybe that's there. Some thresholds. 25 But there should be some added disclosure on - at least in the 0072 1 footnotes. 2 MS. DOPKIN: And, you know, and while there might be 3 some collateral behind the hedge fund in the - in the posting, I 4 mean, it's not a regulated industry in the same extent as other 5 industries. And I would want to know, you know, where - where 6 this counter-party -- who is on the other side of the trade and 7 be able to deem, okay, well, I - I felt more comfortable about 8 this particular entity over another. 9 MR. SURI: And, you know, what is the collateral? 10 If you go back to Enron, is it your own stock? We don't know. 11 Just saying it's collateral (1:38:28) 12 MR. KROEKER: One of the things I think I'm hearing 13 is we don't want less information about uncertainty we want 14 more. And it kind of emphasizes the importance of -- footnotes 15 are integral to financial reporting. I'm not sure how - again, 16 how this takes us to resolve the issue of what uncertainty we 17 want to capture in financial reports, but it emphasizes to me 18 that we need to continue to emphasize footnotes as an important 19 tool combined with MDNA other financial disclosure. 20 MR. SIEGEL: But I also agree with Meredith that 21 it's - it's - it's disclosure that's efficient and effective 22 disclosure and not just more for the sake of quantity. Right? 23 It's - it's don't get lost - don't get the good disclosure lost 24 in - in that - that it might be everywhere. 25 So we have a project that - that's the Disclosure 0073 1 Framework Project to try to address what I hear about from - 2 from every kind of constituent which is disclosure overload and 3 that's something that we're trying to think about. But I think 4 that's actually another cross-cutting topic for - for, you know, 5 the three organizations that are here to - because if - if - 6 it's only going to be successful if people get the right 7 disclosures in the right places and not redundancies in 8 disclosures. 9 We're all going to have to deal with that 10 eventually; what's inside the financial statements, what's 11 outside the financial statements. Having the same thing 12 disclosed in the footnotes in MDNA and in critical accounting. 13 It doesn't - it's - it's not helpful. In fact, it's - it's - it 14 probably serves to turn people away rather than inform. 15 I have a question, though, going - on - on 16 disclosures. And it goes back to something that we started with 17 at the beginning, which was comparability. And so Pinto you - 18 you just using the loan example and then you were walking me 19 through what you would want to understand about loans and by by 20 type of loan or by type of geo - or - or whatever the right 21 level of dis-segregation is. 22 And I have a general question, because this 23 sometimes a tradeoff that we try to - try to have to think 24 through, which is to get comparability we often hear from 25 investors, we want the same type of information, call it a 0074 1 tabular disclosure. We want a table in the same format for 2 every company to do the same way so that - it makes it easier to 3 do comparability. 4 The preparer community often will say, but that 5 doesn't allow me to tell the story and inform you about my 6 business model in in the way that I'm doing business if we do 7 it in the same way for everybody because invariably we have to 8 cut corners to make it comparable. How do we how should we 9 think about that trade-off? 10 Are you comfortable having a little bit of 11 difference of the credit quality disclosures we did earlier this 12 year? For example, we said, however management defines the 13 level of detail that they do their reserving, that's the level 14 of detail that you should use for your disclosures. Now, it's 15 not the same bank to bank to bank. But - but we did that to 16 allow for - to not introduce new complexity into the financial 17 statements, and the footnotes, I should say, and allows 18 management to tell the story about how they're coming up with 19 their reserve numbers. 20 Have those - have those disclosures been helpful for 21 investors or should we rely more on an objective table that's 22 the same from one - one institution for another? And its the 23 same thing when we get to management uncertainty, disclosures 24 and other forms; interest rate sensitivity, et cetera, market 25 risk. 0075 1 MR. SURI: I think they are. I think it depends on 2 inform. So if we're talking about loan stats, for example, 3 right, I think that tabular disclosure - and there's text 4 underneath it to give you color as to what went on and what 5 drove the numbers and what's behind the numbers. 6 But I do - I do think that that's helpful. And if 7 I, you know, translate that not just to banks but also to 8 insurance companies, the recent advancements that have - you 9 know, we've seen come out where, you know, the investment 10 portfolio, which is 70-80 percent of the balance sheet, you can 11 now see very clearly what is amortized cost, fair value 12 impairments. And then what you get to the end number. Right? 13 I think that is very helpful because it pulls it out 14 in one place and it makes it easy to follow and then read 15 through to get the color behind it. That's - 16 MR. SIEFERS: All right. I'd say from my own 17 experience in looking at financial statements dealing with 18 customers and dealing with bank managements, I think what people 19 are looking for, you know, from people like you is - there are 20 just a number of different constituents out there, so I am fine 21 with some differences between individual companies, you know, as 22 long as - I think people are looking for you guys to come back 23 and act as a leader on one of the standard barriers in the 24 industry. 25 So, you know, just to take an example in the - in 0076 1 the banking space, you know, construction portfolios prior to, 2 say, 2007, there was - you didn't know anything about what you 3 saw. But the market imposes that discipline by demanding more - 4 more disclosure. Those banks that are more conservative, more 5 transparent, tend to be rewarded with a higher valuation and 6 others follow suit. 7 So, you know, to the extent that you're - you're 8 able to help be that standard bearer, you know, make sure there 9 are minimal levels of disclosure out there. I think that - 10 that's really what investors are looking for. 11 MS. DOPKIN: I don't know. I mean, Scott, how much 12 are you using on the call reports? I mean, basically, the bank 13 call reports are trying to make it apples to apples and a lot of 14 investors are using the call reports to try and do the exercise 15 that you're saying. 16 I think, you know, in that industry, that works. I 17 mean, does it work comparing, you know - trying to put in a neat 18 box Pfizer versus Lilly? No. But, you know, in some industries 19 having some standardization there's lots of flexibility, you 20 know. Just even in charge-offs, how you account for 21 charge-offs. You know, what type of interest income you might 22 get, where you put the individual in the line item, you know. 23 If you then go to a foreclosure and you get some recovery, you 24 know, where - where it goes on the income statement. 25 There's differences in the GAAP accounting but when 0077 1 you go to the call reports, it's - they're the same. And, 2 again, it's the transparency there and in the individual bank 3 reports for GAAP, not really. 4 MR. STARR: It's been a good discussion. I'd like 5 to go back to two things and just ask for views. 6 One is, we talked about the auditor's role and 7 responsibility. And as the level of uncertainty increases, how 8 does your expectation of the auditor change and what would you 9 have the auditor do? 10 MR. SIEFERS: I think from my own standpoint, just 11 the one thing that I've noticed both personally and in 12 conversations with investors is the one thing that's most 13 important is uniformity throughout, say, the country, you know, 14 by policy, for example, within an individual auditor. So, you 15 know, for example, if - if an auditor is having, you know, nine 16 out of ten banks mark a certain asset to a - to a certain level, 17 there probably shouldn't be an exception somewhere else. I 18 think people are just looking for, you know, a standard and 19 consistent policy at the individual auditor level. 20 MR. STARR: You said, "country," I would assume - 21 MR. SIEFERS: Excuse me. No, actually, I meant 22 country within, you know - I guess - I guess what I was 23 referring to is, you know, if the New York office is doing one 24 thing the L.A. Office should be doing the same thing. Sorry. 25 Didn't meant to slip up a little there. 0078 1 MR. STARR: Anyone else? 2 MR. PENMAN: I was just thinking about true and fair 3 view versus compliance with GAAP. And maybe there's some 4 bridging there that you actually - again, this discussion with 5 the audit committee is to form a substance. And we have this 6 every time we have a crisis, some acronym comes back and hits 7 you, doesn't it? It's very well for City to put BSIBs on the 8 balance sheet after the stock price goes to 99 cents. 9 So what is giving some - some indication, yes, this 10 is compliance with GAAP. You should note that GAAP has a lot of 11 trouble dealing with uncertainty. Okay? And this is a problem 12 here. And we - so this - another opinion expressed, okay. To 13 the extent that clients are handling uncertainty. I don't know 14 what that would be. I'm not recommending a true and fair view 15 in the audit statement. But this struc - this financial 16 engineering, this structuring, really is annoying. 17 (Laughter.) 18 MS. WALTER: I must say, Jim, I'm - that's my 19 take-away from today. 20 (Laughter.) 21 MR. DOTY: I am hearing a message that comparability 22 can suffer a little bit. There's not - comparability is not the 23 holy grail of financial presentation in the minds of investors 24 that, perhaps, it once was. It's important. It's important, 25 but, in fact, you could deal with a little lack of comparability 0079 1 across - between or among preparers in a certain industry if you 2 had the assurance that there was uniformity and that there was a 3 uniform high standard of audit across the country and in the 4 interpretation of the accounting standards by the firms. And if 5 you had confidence in the fundamental audit itself. And that 6 the that the information that we're getting was good 7 information. That someone had looked hard at management's 8 process whereby it reached its critical accounting policies and 9 estimates. 10 Am I wrong? I mean, that's what I'm hearing. 11 In other words, transparency and objectivity, 12 perhaps a little more important after the financial crisis than 13 they might have been in that (1:49:22) 14 MR. SURI: I think it seems transparency is, by may 15 of us on the investing side, overused. You know, we're not 16 looking for transparency as in just complete look through the 17 financials. But at least having an idea that it's been 18 consistently applied. So, you know, we don't want them to be 19 comparable, particularly in financial institutions. I mean, 20 each management is going to have their own view of risk. And 21 that's what we're looking to allocate capital to different user 22 risk. So I think consistency of objection. 23 MR. DOTY: I mean, your remarks have tended to 24 indicate you're mainly concerned that the auditor simply stop 25 short of thinking critically about how management is managing 0080 1 its business model. 2 MR. SURI: Yeah. Basically -- 3 MR. DOTY: You said that earlier 4 MR. SURI: Based on that one-page letter, yeah or 5 nay. 6 MR. KROEKER: I wonder if, you know - is that a 7 consistent - speaking of consistent, is that a consistent view 8 across the uncertainty - the level of uncertainty that might 9 exist because of course at one end of the spectrum of 10 uncertainty it's very difficult to have even consistency, you 11 know, to - it's management's financial reporting. Obviously the 12 auditor ought to be skeptical and objective but at high degrees 13 of uncertainty. 14 If we are going to have thresholds in terms of 15 recording, it's going to be difficult for an auditor to drive 16 even within their own practice uniformity of views of outcomes. 17 18 The interesting question, then, is if there were 19 answers driven by auditors, it wouldn't just be within an audit 20 firm. It seemingly would have to exist for each firm because as 21 companies change auditors, then, that view would then need to be 22 - if there was one consistent view that needed to be imposed, or 23 it really has to be driven at the company level first if you ask 24 me. And I think that becomes more challenging the more 25 uncertainty you incorporate into financial reports. 0081 1 But I don't know if that's - because I heard, again 2 - not that comparability was third as it was listed, initially. 3 I don't know if it was third, but I think that - that's the 4 tension. 5 MS. DOPKIN: You know, and this might be a little 6 off point to the question but take something just as basic as 7 like pension accounting. Right. And you've got companies that 8 have similar pensions but are using very different rates for 9 their rate of return. Some are using different assumptions with 10 the smoothing methodology. Right? And you have half the 11 companies S&P 500 still using a pension return rate above 775. 12 It's pretty hard in a low rate environment, right now, with many 13 of these portfolios to generate that. 14 So, you know, auditors across the board are -- you 15 know, some companies are putting down one number and others are 16 putting down other - other numbers but there's no perfect number 17 but there shouldn't be that wide of a gap, right? And so why - 18 why is that, you know, that we still have a lot of companies 19 using pretty high numbers? So as an investor, okay, what would 20 be useful to me, you know? If they still want to use silly, 21 unrealistic numbers, you know, what is my pension expense for 22 the next two to three years going to be if you use the same 23 interest rate -- you know, same current interest rate 24 assumption, same kind of, like, plan return. And, you know, 25 tell me what the contribution needs to be for the next two 0082 1 years. 2 So the expense and the actual contribution kind of 3 all else, market returns, interest rates staying stable rates, 4 so if you're going to have different - different numbers, at 5 least give us what you think you're going to have and then maybe 6 a little bit of sensitivity around what if it's a little bit 7 lower. 8 MR. KROEKER: I'm beaming as you say that because 9 it's a perfect example of uncertainty. The company has asked to 10 project the expected rate of return on assets for presumably the 11 next 30 years. And an auditor, in driving - so - said, company 12 you come up with the estimate. And it's a pretty uncertain 13 measure. And can an auditor objectively - you could certainly 14 look at the past to see how past assets have performed and you 15 can look at the present to see how they're performing, but the 16 question they're faced with is, how do we think assets will 17 perform for the next thirty. That's a pretty difficulty area of 18 uncertainty to figure out, you know, what is the best way to 19 handle that. 20 MR. KABURECK: Just a couple thoughts on that, I 21 mean, Jim, that came up. I actually was a benefits accounting 22 expert. In fact, two weeks after I started, FAS 87 came out. 23 They said, "Here it is, go do it." Twenty-five years later I 24 still have it. 25 But on pensions, the discount rate is vastly more 0083 1 important to future expense than the asset return. You can 2 adjust the term one percentage point and multiply the portfolio 3 and you can get your number. You can't do the same mathematics 4 offline as an analyst on the discount rate. So deemed - just 5 put that. 6 But going back to where we were a few minutes ago 7 about the auditors and what would we expect to be different in 8 the role of uncertainty, and I'll just make the same comments I 9 did at the Auditor's Reporting Roundtable several weeks ago. Is 10 the auditors got a place but they're not financial analysts and 11 it would be, I think, a disservice, probably, to a lot of the 12 users to assume the auditors actually knew more about what the 13 company's financial affairs than management's itself does. 14 I think the information really needs to come from 15 management through either rule making, through Marc's rule 16 making or PCOB's rule making, as the case may be, but really its 17 management's job to deliver the stuff. And maybe the more 18 uncertainty that there's a number, I think, personally audit 19 procedures and management inspection procedures, personally 20 move, you know, directly proportion to what one would hope. 21 MR. KROEKER: One of the reasons that's a good 22 example, though, is I think what I hears is, even if the number 23 is uncertain, then desirability of saying, what would my outcome 24 be on, you know - if I neutralized, if you will, some of that 25 uncertainty, I think it's just part of the case. And I suspect 0084 1 people saying, if I'm not getting it from the company, I want it 2 from the auditor. 3 MR. LITKE: Yeah, I think with pensions you have 4 you have two very interesting things going on. First of all, 5 you said the auditor shouldn't be second guessing management 6 because management knows how to run their business. With the 7 exception of a couple of old line industrial companies, running 8 a pension fund is not management's business. Management is in 9 the business of operating a company. So that's an interesting 10 area. 11 Or, in fact, management doesn't you know, is often 12 farming it out. They don't know it - how to manage it. It's 13 not what they were hired to do. They're not a financial 14 institution yet they've got this pension fund which is now 15 driving their earnings. 16 I actually quite like your suggestion of saying, 17 well, give it to me on a standardized basis and then you go do 18 what you want. And if you can agree with your actuary that 19 you're solvent, that's one thing. But for earnings, everybody's 20 got to report a single number. I think that's a wonderful 21 suggestion. 22 MR. PENMAN: But on the expected return on the plan 23 assets, I mean, it's a dirty secret in academia, the top fifty 24 years of asset pricing in the calculated pricing model, we have 25 no idea how to calculate the expected return for risk. Okay? 0085 1 Which is a lot of our fair value calculation, a lot of our 2 accounting. And, you know, so we move to actual gains and 3 losses. Okay? So you get rid of that. 4 But, please, don't that the customer sold. You have 5 it coming out on the income statement, way down, as a return 6 from another part of your business. So that's clarity, right, 7 actual gains and losses with in the fair - it's marker to 8 marker. 9 Pertaining to that, we know what the expected return 10 on our portfolio assets, which means stocks, bonds, hedge funds, 11 and so on, private equity, is sort of ridiculous. And we should 12 recognize that. 13 But isn't the second stage supposed to be doing 14 that, on pensions? 15 (Laughter.) 16 MR. SIEGEL: We have so many projects going on right 17 now. We have not added stage two of the pension project to our 18 current front burner projects. 19 But this one's a good one, because this is a great 20 example of - of the dichotomy of long duration-type stuff versus 21 short duration-type stuff. So a pension expense is pension 22 liability is supposed to be a thirty year, say, type liability 23 and therefore to have the big reason - because of the market 24 moving up and down and having that go through the income 25 statement at the time - and from what I'm hearing today, from 0086 1 some people here is, that doesn't make sense to go through the 2 income statements, so let's come up with a mechanism to smooth 3 it out over that thirty year time line. And - and there are 4 problems with that too. 5 So it's - it's - it's a very interesting area and 6 I'm glad it came up because it's a perfect example of what, I 7 think, you know, you were trying to do here with what's the 8 right level of measurement uncertainty disclosures and what 9 should we be reflecting. 10 MR. KROEKER: So I think we have about ten minutes 11 left. It may be a good time to go back to where we started. If 12 there was - because it is your opportunity to give us input on 13 what we should do. You know, if there are changes to be made. 14 If - if we're responding, what is it that investors are asking 15 with respect to uncertainty? Are there changes we ought to be 16 contemplating? Is there a direction we should be headed in 17 financial reporting? 18 Probably your last ten minutes, maybe we could use, 19 you know, what concretely can we take away? 20 MS. DOPKIN: I'll just throw more back on here. And 21 we talked about it before - I think it was Gary - on the cash on 22 the balance sheet. And I think Pinto brought this up, too. 23 We really would like to see how much can be deployed 24 without triggering tax to bring it back. And if you do have to 25 trigger a tax, what would be that liability to bring it back to 0087 1 kind of get a sense for the quality of cash that's available? 2 So just something simple but something I'd like to 3 register a voice on? 4 MS. CANGIALOSI: So I just have to respond to that 5 because it's not as simple as you think is the issue. 6 Because the issue is when you repatriate, you can do 7 it in multiple ways. So - and it depends on the circumstances 8 under which you choose to repatriate. So, you know, how you 9 bring that cash back, when you bring it back, which 10 jurisdictions you bring it back from, which which planning 11 techniques you employee, will all determine what the answer is 12 to the liability question. And for us there's just a tremendous 13 amount of uncertainty. We can do it - you can do it multiple 14 ways. So which one - which one do we show? And to do it means 15 doing a lot of research trying to figure out, maybe, the best 16 way to do it. So that's part of the question. 17 I'll just stop there saying, it is a much more 18 complex exercise than coming up with a number. 19 MR. KROEKER: I wonder if the investors even benefit 20 from just that discussion? You know, a plain English, it is 21 more - it is more complex; it depends, but it isn't necessarily 22 - you don't get the only view by just looking at the balance 23 sheet; you need to understand if it was repatriated, if it was 24 under these circumstances. Would even that language be helpful? 25 MS. DOPKIN I think just a little bit more clarity 0088 1 because we would have to think that a management would want to 2 know the answer to that question themselves. What is the most 3 likely course that we would pursue to be able to take advantage 4 of that cash, perhaps, to do various things with that cash? 5 MR. KROEKER: And, of course, that's something that 6 Meredith's division has painstakingly taking an interest in. 7 MR. GALLAGHER: Jim, I tried to keep quiet but I 8 only have a few minutes left. We've now, I guess, talked about 9 litigation reserves without expressly talking about litigation 10 reserves. And this is an issue that sort of impacts me from the 11 outside. I thought I would try to clarify. 12 I haven't heard yet really what the impetus was on 13 that issue. I haven't heard investors say, that there's 14 something lacking or, you know, that the uncertainty can be 15 pierced there. You know, given my background, having had to 16 prepare litigation reserves for a broker-dealer sub of a public 17 company, I'll tell you, there's nothing less certain than those 18 calculations. I'm not exactly sure, you know, if aggregate 19 level disclosures aren't enough. But I can't imagine, you know 20 - it's so, you know, idiosyncratic as to any management team and 21 any general counsel. 22 You know, I was fairly confident in how I was going 23 to handle litigation. You could zero-out a lot of it but in 24 reality, you know, life and juries and judges don't let you do 25 that. 0089 1 So, you know, on that specific issue, I just thought 2 we kind of abruptly ended there and I was wondering if there was 3 any more conversation from the investor side on that? 4 MR. SURI: Have you ever looked at an insurance 5 company or a broker-dealer, that's just, you know, 30-40 pages 6 right there. And, you know, you look at recent estimates. A 7 mid-size broker-dealer as an example provided a recent estimate 8 for a case at 900, settled at 180, you know. And that's 9 quote-unquote, "an egregious case," that could have been 10 classified that way. 11 We just count them. I mean, that's what you have 12 capital for. And for a financial entity, that's what you want 13 to look for. Again, it goes back to management, you know. How 14 has management managed through the rest of the business? And 15 that is what is going to be translated on to how they're 16 addressing these issues. And if they haven't addressed it, 17 there will be penalties. And some of that is ex-post; can't be 18 expanding that's - 19 MR. SIEFERS: Only a couple of things that come to 20 mind for me as a bank analyst. Historically, litigation 21 reserves haven't been a big deal. Obviously that's changed 22 enormously in the last couple of years. But my own my own 23 sense is that - has been that now that we're providing ranges of 24 disclosures and, you know, the maximum number, for example, it - 25 you really, I think, it's become nothing more than kind of a 0090 1 fodder for criticism. Because I think there is pretty public 2 criticism for some of the largest banks out there, 3 unfortunately. Because I think there are examples of pretty 4 large names out there who have put a dollar value in their cue 5 and then been several billion dollars off twelve days later, you 6 know. 7 So that's not saying I know what the answer is at 8 all but I think it's been kind of a well-intentioned disclosure 9 that has been contorted, unfortunately. 10 MR. KROEKER: One of the - I'll paraphrase it wrong, 11 Stephen, but I come back to what I think you said earlier is, if 12 there's a anchor where we can tell people, we know what we know, 13 but I don't think we can stop there. And we need to tell 14 people, and here's what - and here's the uncertainty and what we 15 don't know. And I think that - that I'm left with -- I'm 16 thinking about how can we foster that, or should we do that in 17 financial reporting? 18 MR. PENMAN: Yeah, I think, to deal with uncertainty 19 by putting uncertainty in the financial statements - I mean, in 20 the balance sheet - in above the line is probably not the way to 21 go. You need something pretty hard. A pretty hard balanced 22 sheet that's, as Benjamin Graham would say, there's no order on 23 the balance sheet. Okay? Which is where the SEC came into 24 existence after all that order on the balance sheet in the 25 1920s. Give me an income statement. And I've sort of got - if 0091 1 sales are the same as in the future, this is probably the income 2 I'm going to get. Some very hard numbers. But then understand 3 there's a level of uncertainty to be dealt with. And that goes 4 along the line. That's sort of the way I think about it. 5 And the elaboration of that was, the disclosure 6 without being becoming cumbersome is a challenge. 7 8 MR. KROEKER: I'd heard a lot during the financial 9 crisis of pre - you know, pre-SEC existence, financial reporting 10 was in many respects a complete fair value model. People were 11 taking intangibles and other things, very uncertain things, and 12 running them through financial statements. And people would 13 say, well, fair value accounting was outlawed at some point. 14 I'm not sure. We did a lot of research. We couldn't find that. 15 It certainly has a very important role in financial reporting. 16 But taking to its extreme of incorporating absolute uncertainty 17 in financial measures, doesn't seem - 18 MR. PENMAN: It's all relevant. And of course 19 there's going to be gray areas. Everything outside cash 20 accounting is estimates. Okay? So it's a question of the 21 quality of the gray. 22 MR. KROEKER: Any parting comments by folks? 23 Five minutes if nothing 24 MR. SURI: I have one. I think for the financial 25 institutions phase we really ought to rethink whether we're 0092 1 accounting for the markets or from the markets. And I think 2 this is that is the one issue that permeates every single 3 sector within financial institutions, to varying degrees, but 4 it's really a big concern for us as investors because all of the 5 burden for getting to those hard numbers then falls on us. 6 And I don't think that's the right place for it to 7 fall. 8 MR. LITKE: Just to add a little bit to what Pinto 9 said. 10 I think you need to make a distinction with the 11 financial institutions, especially, is your accounting a going 12 concern value or a gone concern value? And they're two very 13 different things. You know, the banking regulators recognize 14 this with different forms of capital. But I think you may have 15 to think about that with the accounting as well. To say, what's 16 the value of my firm assuming I'm still around? Your goodwill 17 is in there if you're still around. Your other intangibles, a 18 lot of that goes away, if you're gone. 19 MR. SIEFERS: I guess, you know, to kind of pile on 20 the financial institutions bandwagon, one thing I would love to 21 see - and it's more a plea than anything else - just a more 22 active dialogue between the SEC and bank regulators. You know, 23 we commented about the loan loss reserve issue. But, you know, 24 that's been a huge issue for investors for the better part of 15 25 years now. I would love to see things like that get 0093 1 rationalized. 2 You know, the fair value issues, the same kind of 3 thing. You know, they come into really full view at times when 4 it's least opportune for them to do. 5 So I'd love to see, you know, an active coordination 6 there. 7 MR. KROEKER: Just to respond, it's something we do 8 coordinate very closely on day to day basis but we also have 9 quarterly meetings with the bank regulators. But I think a good 10 piece of advice that even an event like today, thinking about 11 should there be, you know, role of uncertainty in financial 12 reporting, and is there a financial institution regulator's 13 perspective, helpful advice. 14 MR. KABURECK: A non-financial institution comment, 15 I think, in the wrap-up is, you know, the pendulum swings over 16 time and for the longest time things were swinging towards 17 accrual basis accounting. Maybe for the last ten years it's 18 been towards fair value accounting. I might suggest perhaps a 19 little bit more focus on - I'll just call it "cash liquidity 20 claims to cash," statutory contracts that are off book that 21 might cause cash inflows or outflows. Because accrual basis 22 accounting is fine. GAAP base is equity is fine. But 23 ultimately cash pays the bills and it pays the dividends. 24 Ultimately your share price is a discount of future cash flows 25 not future income flows. 0094 1 So, again, I mean, everything's got a role. There 2 is a cash flow statement but it's been in the third or fourth 3 statement, not the first statement. So perhaps a subtle shift 4 towards more of an emphasis on the cash content of items or the 5 potential future cash content items. 6 MS. CANGIALOSI: Just as a wrap-up, as a preparer, 7 I'm very interested in what, you know, users are really looking 8 for because we want to provide them with information that's 9 useful to them. Not just provide them with lots of information. 10 11 And one of my concerns is always, providing lots and 12 lots of detail tends to bury anything important. We tend to 13 make a lot of disclosures that seem obvious to me; things like 14 in risk factors, well, if we can't sell our product, so we won't 15 have any revenues. You know, those are very obvious things. 16 I just would say, you know, most preparers want to 17 do the right thing. We just don't want to do kind of things 18 redundantly or just over the top. So, you know, things that are 19 really useful and - and as somebody pointed out, the market 20 generally gets those things in the financial statements because 21 that's what comes out to management is, it would be really 22 helpful if we had this information. And you do see that, the 23 users can really have an impact there. 24 MR. KABURECK: Well, the users, I think, are not a 25 homogenous group. And Lorretta and our colleagues we fret about 0095 1 that all the time. Users - what they're called, users and 2 investors, there's a wide variety of them. And the people in 3 the room know better than I, they've got different needs and 4 interest. But if collectively they're all viewed as equal, 5 you're going to have disclosures that are good for one segment 6 and not another. And what you'll end up with is a huge bulk of 7 disclosures. 8 I don't know if it's practical or even appropriate 9 to say, is there a pecking order of users that appreciates your 10 mission as investors but there's a lot of other users as well. 11 And their needs and interests are very different from each 12 other. And ultimately you solve it by giving it all there 13 because - and there's an awful lot of information in there that 14 I don't have an answer to it, but I suspect there's no easy 15 answer. 16 MR. KROEKER: Meredith, Marc, Chairman Doty, 17 anything in closing? 18 MR. DOTY: I'm left with the question, how much 19 uncertainty we can take in financial reporting? And with the 20 question of, given the fact that there's inherent uncertainty, 21 is it our job as audit regulators to be sure that the public 22 understands the uncertainty that lies behind an audit report? 23 And what, if anything, can we or should we be doing to make the 24 parameters of the things that describe that uncertainty, that 25 fix that uncertainty, clear to investors? And I think we have 0096 1 the rest of the day to hear more about that. 2 MS. CROSS: I'll just mention that my division's 3 role is to use the rules that we have and try to enhance 4 company's disclosures through the comment process. We're always 5 a little bit behind where you want us to be. Maybe way behind. 6 But we're always aiming to get the meaningful disclosures. 7 And the companies, for the most part, are 8 surprisingly cooperative when we go about a new disclosure goal 9 such as, you know, additional information about repatriating 10 cash or any of these other topics. It's helpful to us if we - 11 if we can use the rules as sort of living, breathing, flexible 12 rules so that we can then seek information like that. It helps 13 us when the companies are cooperative, when they're auditors are 14 cooperative. It also helps us to know what information 15 investors actually want. 16 You know, my staff reviews analyst reports now. We 17 review - we listen to the earnings calls. We hear the questions 18 analysts are asking. We do everything we can to try to get at 19 that but it would really help us to know in any industry or even 20 particular company what information you think would be useful. 21 I really do think a lot of these uncertainty 22 questions can be solved with supplemental disclosures rather 23 than trying to measure things that are really inherently not 24 measurable. 25 And we don't - I think it's better if the 0097 1 information can be fluid so that companies are comfortable 2 dropping it off after a year or two when it's no longer that 3 interesting to investors and instead now do something else. I 4 think companies are very afraid to take something out once 5 they've put it in. And I think showing some flexibility that 6 it's okay, you know, that's not today's issue anymore, let's 7 look at this issue. 8 But we would love to hear from investors about what 9 would be useful information in our filing reviews. 10 We look at the largest company's 10ks very shortly 11 after they're filed in March. We pick them up and start looking 12 at them. So if there are things you want us to be focusing on 13 in those 10K reviews, let us know. 14 MR. KROEKER: With that, thanks to each of the 15 panelists. I suspect that this will be an interesting topic 16 even for, you know, a more focused follow-up of the financial 17 reporting series. We may be calling on some of the same folks 18 around the table to assist us if you're willing. 19 Thank you. Let's reconvene the second panel at 1:15. 20 (Off the record.) 21 MR. KROEKER: Well, let's go ahead and start the 22 discussion with the second panel. 23 Once again, I want to thank each of the panelist for 24 agreeing to participate. We appreciate, in advance, the input 25 and particularly the fact that you're willing to go out of your 0098 1 way to take time out of your schedules and your lives to provide 2 us the input. 3 So with that, again, each panelist's, background 4 information is available online. 5 I'd like to maybe start with a similar question to 6 this panel as we did the first, which is, the whole objective 7 here is to provide information that is useful to investors and 8 users of financial statements. Of course, it's particularly 9 interesting and a struggle to figure out what is it that 10 investors are looking for as it relates to uncertainty. 11 Maybe to drill down a level if you have suggestions 12 as to are there, for example - is there a framework that you 13 look at? What types of uncertain measures should be captured in 14 measurement on the balance sheet? Are there situations in which 15 you go beyond the threshold that you would say, no disclosure is 16 really what we need either as a substitution to recognition or 17 to supplement recognition. 18 I think we start, with again, the same broad 19 discussion but very interested in are there characteristics that 20 would be helpful in sorting through the types of information 21 that would be useful to investors and then how to best present a 22 comprehensive package? 23 I'll just turn it over to the group and moderate 24 much like we did before. The PCAOB Chair and FASB should feel 25 free at any point to jump in, as I'm sure they will. 0099 1 MR. NEWSON: If I could just make, I guess, a high 2 level statement of how I look at financial statements in 3 companies. 4 In each case and each case is a little different, 5 you know, from company to company, even within the same 6 business. And so I try to get down to understanding the 7 economics of the company. And financial reporting standards are 8 a lens in our pathway that hopefully gets me there, but in most 9 cases, you know, the financial statements themselves don't give 10 me what I'm looking for. 11 And so I usually ask lots of questions or I look for 12 other information, like statutory statements for insurance 13 companies. You know, banks have their own reporting system as 14 well. And then service companies, you know, tend to have, you 15 know, management reporting or other, you know, advisory type 16 reports. Especially in a purchase type situation. You know, 17 accounting due diligence and so forth. 18 The financial reporting standards are never perfect 19 and there's always a navigation that takes place, you know, from 20 gaining ten. 21 MR. LONGINO: Let me just say on behalf of all of 22 us, Jim, how grateful we are to be here. It's a pleasure and a 23 privilege. We appreciate your reaching out and taking an 24 interest in what investors and other uses and preparers of 25 financial statements think on the topic. 0100 1 I'd like to echo a sentiment that was expressed, I 2 think, by Jennifer Paquette of the first panel this morning when 3 she said that we're not looking to financial statements to do 4 the analysis for us. And we're not expecting that. And it 5 really ties in with another observation that was made which was 6 that of the three of the triumvirate of things that Scott Siefer 7 started off by saying investors are looking for, transparency, 8 comparability, and objectivity, perhaps the hardest of these is 9 comparability. 10 And that really is something that the analysts, I 11 think, is responsible for doing. I think what analysts in 12 general want is the best information possible. And they then - 13 it's their job to take that information and to - to adjust for 14 comparability in order to make decisions about allocating 15 capital. 16 So I think that a lot of concern that some of the 17 accounting profession goes through about what needs to be 18 provided and where it needs to be provided is, to a certain 19 extent, unnecessary. The information needs to be there. 20 Whether it's in the financial statements or in the disclosure, 21 but it needs to be there. And then it's the job of the analysts 22 to take and do that what his abilities and likes suggest. 23 I also think that insofar as what goes into the 24 financial statements, the business strategy, the business model, 25 of a particular reporting entity and sectors of reporting 0101 1 entities are the gatekeeper, or should be the gatekeeper, of 2 what goes into the financial statements and what doesn't go into 3 those financial statements and what's disclosed otherwise. 4 The example that came up this morning was a fair 5 value for broker-dealers in their operations in carrying all of 6 those assets and securities at fair value is appropriate for 7 them because that's their business model, but it's not 8 appropriate for banks, which are not mutual funds and which are 9 not hedge funds. 10 And so I think that's one way in a general sense to 11 respond to your question. 12 MS. CAMPBELL: And to echo that in both in thanking 13 you to have these panel discussions which I find quite 14 encouraging that you're getting direct investor feedback and 15 also to just comments kind of giving more context about what 16 analysts are really looking for. 17 Most analysts are not accounting specialists, you 18 know. We've learned accounting by using the statements. And 19 most of the time is spent on making sure that we understand both 20 the industry of what the companies themselves are doing. We 21 spent time on the valuations so we know whether or not, you 22 know, it's fairly priced. Understanding that as investors we 23 all have different opinions about that. That's what makes the 24 market. 25 And using - financial statements are our tool. I 0102 1 can't ever recall a time when we - when investors have sat 2 around really debating about some obscure part of an accounting 3 standard. We have opinions about, you know, fair value and good 4 will and things of that nature, but it's - it really comes down 5 to are the financial statements reflecting what the economic 6 realities are of the business. How can we get a better 7 understanding of what management's decisions are and what 8 they're looking at. And then it's our own judgement of how that 9 fits in with what we're trying to accomplish with our 10 investments themselves in that allocation of capital. 11 And, you know, it certainly seems that over the last 12 several years that there's been somewhat of a departure or a lot 13 of a departure from the standards side of away from 14 concentrating on what can be known and trying to turn both 15 preparers and auditors, to some extent, into analysts. And that 16 makes it less clear for us. 17 So this uncertainty focus that, you know, I 18 appreciate that you're all concerned about and trying to get a 19 better understanding of, to me has been magnified by the fact 20 that you're trying to make auditors and preparers doing more of 21 our job. 22 And personally I'd like to see more concentration on 23 what we can know and also a better understanding of how 24 management's themselves are using estimates that are necessary 25 to do their jobs so that when - when we're trying to make a 0103 1 decision, we can say, "Well, we either agree with that 2 management's assumptions or we don't." But it's not - it's not 3 necessarily a right or wrong issue, it's more of, okay, well, if 4 man - this reflects what management thinks. The business is 5 going in "x" direction, well I don't happen to agree with that. 6 I think it's going in a "y" direction and then being able to 7 back that out. 8 MR. STARR: Terri, I want to ask a follow-up 9 question. And actually anyone can jump in and answer this. 10 But you said that you wanted to know more about 11 what's known. Can you give me examples of current accounting 12 where there's measurement uncertainty introduced into the basis 13 for the accounting and that's not useful to you? 14 MS. CAMPBELL: I think it's a couple of things. A 15 lot was talked about in the prior panel. One is, is aspects of 16 fair value whether or not - I mean, to Joe's point. Whether or 17 not the managements are managing their businesses that way. I 18 mean, it is different for a broker-dealer versus a bank. 19 The other piece of it is goodwill. And, you know, 20 no one can tell me that you can take goodwill that's shown up on 21 an asset -- on a balance sheet as an asset that you can actually 22 do anything with that. You can't liquidate it. You can't sell 23 it to somebody else. You can't draw cash out of it. It's this 24 accounting creating that from a management standpoint has not 25 other role than to try to kind of minimize the impact to the 0104 1 bottom line. 2 But it doesn't have any kind of impact in whether 3 they're making a decision of necessarily - well, it could be on 4 exiting a business, but of whether or not they're going to be 5 able to access that for any cash needs. 6 And, you know, one of the things that's kind of a 7 follow on from this morning's discussion of, you know, 8 materiality and how do you make a decision about what's 9 important or not important, of kind of stepping back from that, 10 because it's so easy to get just bogged down in all the details 11 of it and saying, well, what is the - what is the cash impact on 12 it? Because managements are looking at running their business 13 from a cash - I mean, really from a cash standpoint of what cash 14 is coming in. What cash is going out? What am I going to be 15 using my excess cash for? Is it going to be acquisitions? Is 16 it going to be returned to shareholders? And kind of 17 understanding that that's how you need to run your business 18 because if you're not paying attention to cash, you're not going 19 to be in business for very long. 20 So we would like to see more disclosure of that. 21 And even though we have a cash flow statement, it's - it's done 22 in an indirect way. It's hard to - it's hard not to do that 23 from an indirect way, but because of that, it makes it a little 24 bit useless, you know. To a certain extent, yes, I mean, you 25 kind of come up with this cash flow from operating number, 0105 1 investing number, a finance number. But, you know, whenever we 2 look at it - or whenever I look at it, you know, I have to 3 really question, well, how much does this really reflect their 4 reality of the decisions that they make? 5 I followed energy companies and tech companies 6 before, not financial services. And, you know, it's - it's - 7 it's something that I spent a lot of time looking at of what are 8 - how much cash do they really have; what are their assets and 9 how are they going to make decisions of getting a better return 10 on what they have. 11 And I would take out good will, because what are you 12 going - what are you going to do with that? And I'm going to 13 look at, well, what's the cash flow for their core businesses. 14 So it's kind of always coming back to, what are the 15 economic uses of this and where are the - where are the, you 16 know, gaps in the GAAP accounting? No pun intended. Where am I 17 going to have to get additional information from the management 18 for greater clarity on it, which is always going to be the case. 19 They don't - I don't think anybody expects that accounting is 20 going to be a perfect reflection of what happens in the 21 business. You can't. You've got too many industries. It's 22 going to be more of do we understand those flaws are for this 23 particular business and we can make adjustments for that. 24 MR. STARR: Just so I'm clear. If I summarize that, 25 what I would say - what I heard was, that you'd like less 0106 1 uncertainty in the financial statements, in the recognition of 2 assets and liabilities, and you'd like more disclosure about 3 those uncertainties that impact future cash flows? 4 MS. CAMPBELL Yes. 5 MR STARR: Okay. 6 MS. CAMPBELL: Yes. 7 MR. MUNTER: One of the things, again, Jim, I think 8 it was inherent in the way you teed up the question is, we 9 sometimes have a tendency to think of uncertainty as an on-off 10 switch that we ascribe almost an aura of precision to certain 11 measurement attributes. Cost, we somehow think of as being a 12 precise measurement attribute. A level one fair value measure, 13 we think of as being a precise measurement attribute and I think 14 that over simplifies it. And the reality is, there's 15 uncertainty inherent in virtually every measure in the financial 16 statements. There's certainly more uncertainty in a level three 17 fair value measure than there is in a level one fair value 18 measure. But in a level one fair value measurement, we took an 19 observation of a single trade, it happens to be the last one on 20 a particular day, as the basis for measuring it. And had we 21 taken a different trade on the same day, we could well have 22 gotten a number that's different by a significant amount. 23 So I think it's really a question of thinking about 24 gradations, which is in reality kind of how we think about it 25 from an audit perspective. We think about the kinds of things 0107 1 we need to do around controls. The kinds of things we need to 2 do to understand management's processes. The other information 3 we try to look at is as we get more and more down the spectrum 4 of a greater degree of uncertainty, there's obviously more work 5 that has to be done around that to - to have sufficient evidence 6 to support it both from management's perspective and from an 7 audit perspective. 8 I think when we - when we talk about, you know, the 9 transparency, another thing that we sometimes equate with 10 transparency is more information. I think part of transparency 11 has to be trying to get at these distinctions of where within 12 the spectrum of measurement uncertainty are we? I mean, as I 13 think about some of the things that Marc and his colleagues at 14 the FASB are working on with the disclosure framework project, I 15 think that has the potential to be a very important project 16 because it can provide some kind of a framework or thought 17 process for trying to differentiate those uncertainty 18 measurements. 19 Now, I also appreciate that's an extremely difficult 20 undertaking that they're embarking on. But I think that - 21 that's inherent in the process. Now, even if we go back to 22 something like historical costs, I mean, we don't have a 23 standard measure of historical costs. Sometimes we use direct 24 incremental costs. Sometimes it's direct incremental costs plus 25 allocable employee costs. Sometimes it's that plus allocable 0108 1 overhead. 2 So even within that spectrum of historical costs, 3 there are gradations of precision to less precision imbedded in 4 that. 5 MR. STARR: I think we would agree with the fact 6 that there's a lot of uncertainty. I think the question is, 7 where is it too much? 8 Mar, you were going to jump in. Did I - 9 MR. NEWSOME: Yeah, I was going to - well, first of 10 all, your question was interesting because I don't think, you 11 know, in those terms. So I guess a couple of examples related to 12 your question where things are not useful. Before I give you a 13 couple of examples, I usually think about each piece of 14 information and what I can get out of it. 15 In a lot of cases I skip right by it or I just have 16 a mental checklist, like, goodwill, for example. If there's an 17 impairment, then I think, okay, did they mess up on an 18 acquisition. That's kind of, you know, what I get out of 19 goodwill. And then what are the cash flow implications going 20 forward? 21 One example that I came across a few years back was 22 a company went essentially from cash accounting in its service 23 contracts to a differed revenue model because the auditors said, 24 all of your peers do it this way so you should do it this way. 25 And the problem I had with it is, you know, there 0109 1 was a huge balance sheet implication measurement and so forth, 2 and under the contracts, the legal contract, the company had no 3 obligation to return any money under this performance 4 obligation. So in my mind that didn't reflect the economics. 5 So and I think legally it didn't reflect the 6 economics. But the accountant said, this is the way it's got to 7 be done. 8 And so I would turn the question back to, when does 9 accounting not reflect the economics of a situation? And there 10 are probably a myriad of examples. 11 Another one that I run across most of the time is 12 deferred taxes. You know, I've yet to understand, you know, how 13 that works especially when you have a deferred tax on an 14 intangible asset that's not worth anything. 15 So I asked the CFOs all the time and they say, well, 16 we've got to do it that way. 17 And - and so to your subsequent comment, Mike, about 18 uncertainty, you know, I believe that management deals with 19 uncertainty for a living. That's their job. Right. All the 20 way down to the budget for the next year or the medium term 21 forecast or the actuarial loss reserves or the loan loss 22 provisions, or, you know, accounts receivable, and debt reserve. 23 And so what I want to know is, you know, what are 24 the range of possibilities? And what do they think's going to 25 happen? And then I'm going to measure them against what 0110 1 actually happens versus what they thought would happen. Right? 2 And by definition, if they're pretty close, then they're 3 probably doing a decent job. Right? They're good at managing 4 that uncertainty. And if they're off materially, well, why? 5 And sometimes it's out of their control and sometimes, you know, 6 they just didn't manage the process correctly. 7 MS. CAMPBELL: And, Mark, I have a question on that, 8 too. Is that - do you need to see that on financial statements 9 or is it okay to get that from MDNA and from the discussions, 10 you know, during quarterly calls? I mean - 11 MR. NEWSOME: I think it would be hard to put 12 everything in the financial statement itself. Right? Then 13 you'd have a balance sheet with ranges, you know. You know, 14 from minimum to maximum, you know, with a selected target. You 15 know, kind of like what an actual report gives you. 16 So it doesn't have to be on the face. But there are 17 cases where I suggested in the past that maybe you should put 18 fair value and the cost value on the balance sheet, you know, 19 juxtaposed or parenthetically or what have you. You know, pick 20 a format so that somebody like me can easily see, oh, fair value 21 is 30 percent different from cost. Well, why is that? 22 And I've asked these questions of management, 23 especially those managing assets. And what I'm expecting to 24 hear is that they have a particular view; it's under valued or 25 we can wait it out. It's temporary market imbalance. Whatever 0111 1 the reason, I'm looking for a reason, and then I'll measure them 2 on that. Right? A year later. Did it come to fruition or two 3 or whatever their advice is. So - 4 MS. CAMPBELL: Okay. 5 MR. BEGG: Like Mark, we think a lot about 6 business economics when we're going through financial 7 statements. I'm Chief Investment Officer so we're looking at 8 equity and credit. So right away I'm - I start at a level of 9 trust. If it's a new company -- if it's a company we've had, 10 it's a deserved trust. I look at ways they're taking that trust 11 away by not being forthright in maybe something that's complex 12 or something that could be described better through disclosures. 13 So I was mentioning to Mark, you know, one of the 14 things that sometimes when you see complexity enter a system 15 like we have today with, you know, the situation in 2008, 16 instead of trying to figure out ways to fix problems, the way I 17 think about it is, look at something that's working well. I 18 think a model firm that we use - we're a shareholder in, which 19 we think the financial statements are perfect or quite as close 20 as they can be to perfect is Bircher Hathaway. And it's a very 21 complex business. It's an insurance company. It's a holding 22 company. A lot of underlying company. 23 The way that I think that - the way that I think the 24 disclosures and the way the narratives read through that 25 financial statement is if someone who had a moderate background 0112 1 in financial statements in accounting could figure that out. 2 And the more complex the situation, the more description that I 3 think they go through. 4 So that's what I like to see. And as a standard 5 setter, it's hard. How do you create those standards so that 6 more people take up those - those things? 7 But I think the incentive I think for management is 8 if you spend a lot of time upfront with your financial 9 statements in disclosures, in narratives, are you answering 10 those same questions every quarter, every month, to Mark, to me 11 on all the things that are missing like the estimates they use 12 to figure out a pension liability or whatever the situation is. 13 But every time I talk to the IR team up at - what are the top 14 five questions you're getting. And they're getting all the same 15 questions. So if they could spend more time in, I think, the 16 narratives and the disclosures, I think there's an incentive 17 there to save their own time. 18 So just as a high level I'd just add that. 19 MR. SIEGEL: I'm going to jump in there. I think 20 what I hear you - when I hear you go through that example, what 21 occurs to me is - is - is almost a different mindset of the 22 financial reporting disclosures than what other people sometimes 23 think of. 24 I mean, the disclosures we often hear from many is 25 that it becomes almost a checklist mentality. We have to make 0113 1 sure we have all the disclosures that are in the required - that 2 are required by GAAP. 3 What you're describing is let's think of the 4 disclosures less as a checklist. Let's think of it more as a 5 communication vehicle on some of the things the SEC does with 6 the Plain English Initiative, et cetera. 7 MR. BEGG: Absolutely. 8 MR. SIEGEL: Let's think about how to use these 9 these these required disclosures under the framework of let's 10 communicate what's going on in the business as opposed to just a 11 set of things that are required. 12 MR. BEGG: Correct. Yeah. 13 MR. SIEGEL: That's something that we should think 14 about at FASB when we're talking - when we're designing our 15 disclosure framework and trying to devise a means of useful of 16 communications. 17 Thanks for that. 18 MR. GLOVER: As we talk about - thank you, again, 19 for having us. This is a very useful exchange. 20 As we talk about formats of financial statements, I 21 think it's useful to kind of think of what's happened over the 22 last three or four decades. 23 So we went from financial statements that had 24 footnote disclosure that was maybe two pages. Into the nineties 25 where it was maybe 18 to 20 pages. On the PCAOB roundtable last 0114 1 month, on the auditor's report, there was a statistic that the 2 average in some industries is 276 pages of footnotes, some up to 3 480 and there's MDNA. 4 So as we've gone from historical costs, which has 5 estimation uncertainty, more to fair value, we've had this 6 trade-off. I think someone earlier said the trade-off of 7 somewhat more reliable, more verifiable, to more relevant. 8 Because historical costs over time becomes less relevant. 9 But Terri used the term that the financial 10 statements are a tool. And there's that old saying if the only 11 tool I have is a hammer, then every problem's a nail. And it 12 seems to me that the solution to the changing in moving more to 13 estimates, judgements, fair value, in that same PCAOB transcript 14 the chief auditor happens to be here - so I'll see if I quote 15 you right, Marty - said financial statements are nothing but a 16 mass amount of estimates and judgements and they're anything but 17 accurate. They're based on the assumptions and estimates used 18 by a company. 19 In that roundtable the users said, we'd like a 20 roadmap. We got 300 and 400 pages of footnotes. It would be 21 nice if the auditor would identify four or five risks. 22 So I think the SEC and the FASB can think of is 23 there - is it time to rethink the format of the financial 24 statements? 25 Right now there is, as the background reading said, 0115 1 a brittle illusion of exactitude. All the numbers show up as a 2 point estimate. 3 Paul said there's this range of uncertainty. Mark 4 said it would be nice to know what the uncertainty is. The 5 research question we had in a recent paper is, how big is the 6 uncertainty? So we took public company financial statements and 7 looked at the hypersensitivity of changing some of these inputs. 8 You think about pension accounting, mortgage-backed securities. 9 What we found was very, very small changes in those inputs had 10 a highly material, in fact, multitudes of materiality. 11 So we have estimates that are pretty precise that 12 are maybe within what we would consider materiality on the 13 financial statements. We also have estimates that are plus or 14 minus many times materiality and they're reported on the face of 15 the financial statements. 16 So one formatting option might be to say, here's a 17 column of numbers that are fairly precise. Here's a column of 18 numbers that are not so precise. And then that's a roadmap to 19 say, why not. And where does the footnote take me on those? 20 So I think there are different ways. Someone 21 earlier said, maybe we need financial reporting on, I think the 22 term was core business versus changes in values. I think 23 instead of adding more disclosure, more MDNDA, there might be a 24 clever way to provide a better roadmap on the face of the 25 financial statements. 0116 1 MR. WALSH: I just wanted to thank everyone for 2 coordinating these roundtables. I do think it's encouraging 3 that you're listening to the investors and trying to get our 4 insight on what's going on. 5 I do question the value of any roundtable that would 6 have me as a participant, but I do appreciate being included. 7 In terms of uncertainty, I guess going back to what 8 Terri had to say. I too would like to eliminate every bit of 9 uncertainty. However, I do recognize that - the - the - we tend 10 to be very long term investors in our shop. And I do recognize 11 that sometimes the most attractive entry points are when stocks 12 are at the maximum point of uncertainty. So I guess what I'd 13 really like is uncertainty with all of the stocks that we don't 14 own and known uncertainty with things that we own. 15 We - we tend to use financial statements in concert 16 with a lot of other pieces of information. Part of it is to 17 value the businesses that we invest in. But also uncertainty 18 plays a big role there. And we recognize that the - that there 19 is uncertainty into that valuation equation. 20 The other thing is we like to assess management in 21 the decision-making ability of management. And you can get a 22 pretty good insight as to how strong a management team is based 23 on their ability to assess a situation and provide a point 24 estimate or a range of estimates. 25 So - so we recognize that there are a lot of changes 0117 1 that take place. And every estimate is going to be wrong. It's 2 just a matter of was it wrong because the world changed or was 3 it wrong because management didn't incorporate all of the right 4 variables. 5 And so - and both of those tell the investors 6 something about the company they're investing in. 7 MR. GLOVER: So Gary and Mark you both mentioned 8 estimates and ranges. Do you have a sense now from the 9 footnotes that you can determine what would be considered a 10 likely range, a reasonable range? And if not, would you like to 11 see a likely or a reasonable range? So point estimate and then 12 here's our best estimate of what the reasonable range? 13 So two valuation experts don't agree but they agree 14 on a reasonable range, perhaps. 15 MR. WALSH: I'll take a shot at it first. 16 I don't think there is an ability to have a precise 17 - give you any - any comfortable range that's appropriate. In 18 certain circumstances the range will be much broader. 19 I think what's important for us is to be able to 20 look into the assumptions that underlie those estimates. And 21 that way the pension example last round was really - was really 22 good because everyone can have a different view of what the 23 world's going to look like but if you have a sense of what the - 24 of what their assumptions are, you can - you can do sensitivity 25 analysis on your own by coming up with your own - your own 0118 1 estimates. 2 So I think an ability to go into the underlying 3 assumptions is an important component. More important than any 4 percentage range. 5 MR. NEWSON: I typically have to ask management, I 6 have to have a conversation to get at that information you're 7 asking about. 8 MS. CAMPBELL: Yeah. And my concern on having the 9 range is that the ranges aren't any better than the point 10 estimates are. And that if - and then you come into the 11 question of, well, what happens with liability? What happens 12 when the reality goes outside of what those ranges are and what 13 are the ramifications of that? 14 It's - to Gary's point, it - what gets disclosed is 15 information in itself. What managements choose to share with 16 you, has value. And there are certainly investor friendly 17 companies and managements versus not. And that will play into 18 the valuation that we assign an investment because it gives us 19 either confidence or not. 20 So that's - you know, I've seen proposals before 21 about changing the financial presentation and having estimates 22 in it. A d, you know, as I look at how we value things, I don't 23 see how that adds anything. In some ways it further clouds it 24 because we already know that there's a lot of uncertainty with 25 it. 0119 1 MR. GLOVER: Would it not be helpful, though, to 2 say, you know, Paul gave the example, some things have more or 3 less of a range. At least for some users it might be useful to 4 say, well, how big of a range is there associated with certain 5 estimates. 6 Some numbers, you know, we talked about cash this 7 morning. It turns out it's not as precise as we thought. But 8 at some companies, it probably is. And at others, it isn't. 9 And as you go down to accounts receivable, there's 10 uncertainty there but that range might be fairly predictable. 11 Once we get to something that's more or a level 12 three, it is a big range. I think the information's not that 13 they're saying, this is the exact range. I think the 14 information is, how big is the range. Some of these are pretty 15 tight. Some are big. 16 And if we provide a reasonable range of the inputs, 17 like you said, then you can see what the math is on the pension 18 accounting. If it changes by a hundred basis points, what 19 happens? 20 So I don't think you would ask management to say, 21 this is - reasonable I don't think conveys the actual range. 22 But I think their monies in their business by understanding the 23 risks. They're making decisions to acquire companies. 24 We heard this morning that we acquire company, we 25 have to take the difficult accounting for the intangibles. They 0120 1 had done something to decide to go into that business to start 2 with. It made sense to them to take the risks. 3 So as we talk about how better to convey, there 4 might be expertise here where you sort of say, if you give me 5 the right pieces of the puzzle, I'm smart enough to put the rest 6 of the puzzle together. I don't know if that is all of the 7 users of financial statements. 8 MS. CAMPBELL: And certainly having the assumptions 9 would go a long way to that, but the thing that is popping into 10 my mind as we were talking about this, an example would be the 11 liabilities right now that many banks are faced with on their 12 mortgage business. And how much of a put back they're going to 13 have to deal with and then what are the - what are the 14 investment lawsuits that are going to be coming out of this? 15 What are the actual losses that they're going to have on their 16 portfolios? And the ranges that you see from that, from the 17 street, not from management, have a tremendous range from, you 18 know, twenty billion dollars to, you know, two hundred billion 19 dollars for a single company. 20 And, you know, because it kind of goes back to what 21 Paul's saying. These are all unknowns. We can't. Management 22 can't know. You just have to wait. You have to kind of wait it 23 out. See how some of those lawsuits play out. See what kind of 24 gets - the negotiated settlements are. 25 But, again, I kind of go back to, yeah, I'd like to 0121 1 see what management's thinking about that. I think that they're 2 going to be a little bit cautious. They don't want to scare the 3 market by having too big of a number. But they're going to have 4 to balance that out because if they have an un - if they give a 5 too small of a number that's unrealistic, everybody's going to 6 discount it anyway. And it kind of falls back onto the investor 7 to make that assumption themselves. 8 But if we had a better understanding of, okay, what 9 are all the different areas that you're going to be effected by, 10 you know, we'll put a value to it. And - but it is helpful to 11 know what managements looking at and where the pressure points 12 are going to be. 13 MR. SIEGEL: So, Terri, on - can I ask you on that 14 question. The litigation contingencies, right. And this is the 15 question of when you measure - this was Mike's question earlier 16 - when should the uncertainty go from a disclosure - go from 17 nowhere to a disclosure to a - on the balance sheet? So 18 litigation, the put back issue that you mentioned today, 19 wouldn't be reflected on the balance sheet until management 20 believes that it's probable that you're going to incur the loss. 21 And you can reasonably estimate - I'm simplifying - but you can 22 reasonably estimate what that - what that's going to be. 23 If it's - if you don't hit that hurdle, you would 24 disclose information about it. Is that an appropriate threshold 25 to get some of that uncertainty onto the balance sheet or would 0122 1 you prefer not to have any of that uncertainty on the balance 2 sheet and just have disclosures? 3 MS. CAMPBELL: Depending on the timing of it, how - 4 how much - how much management really thinks that they know 5 about that. I want to see it - I want to see it in the 6 disclosure. I don't necessarily want to see it on the balance 7 sheet until they actually have to pay it out. 8 But how I've used disclosures in the past has been 9 not because I have a lot of confidence that they know what the 10 final number is, especially if there's jury awards or, you know, 11 I mean, it can be a humungous range. It's an identifying factor 12 to what - what are management - what's the management worried 13 about. 14 So if they have - if they're identifying particular 15 lawsuit and they said, well, it's - and it's an energy company, 16 for example. Lots of lawsuits there on lots of different 17 levels. You know, whether it's environmental or employee or 18 whatever. And they'll say, you know, this is not going to be 19 material to the outcome. 20 But then there will be something that's big. 21 They'll be Valdez or Exxon and the managements will kind of try 22 to give an estimate of what they think that - the clean-up costs 23 are going to be and what - there might be any penalties and 24 they'll start to reserve for that. 25 I still - I want to see that more in the notes than 0123 1 I do on the balance sheet. This is a personal opinion and how I 2 use it. And if - if it's still so far out in the future, it's 3 going to be a long time before we know what all the liabilities 4 for Bank of America are going to be. 5 It's - to me it makes the - if you had all that 6 flowing through on the balance sheet or within income statements 7 below the line, it doesn't really give me any information. I'm 8 going to back all that stuff out anyway, because it just - they 9 can't know. I mean, and I recognize that. 10 So it doesn't really give me any additional 11 information by having that flow through the financial 12 statements. I already know that it's going to be a big number 13 by looking at the disclosure. I know that I can't get an exact 14 number because that's not really going to play into it anyway. 15 And that's where I do a scenario analysis of saying, okay, if 16 it's "x," then here's an evaluation it would be and this is what 17 the hit's going to be. And if it's "y," then it's going to be 18 this. And we make that judgement call. 19 I don't know if that helps address that. 20 MR. DOTY: He asked about standards. We've been on 21 standards. I want to switch you to audit and the relationship 22 of audit to standards. Because what both you and Mr. Longino 23 said raises the question of what you want from the audit. 24 If you want - and I agree - you want the risk of 25 material litigation to be discussed. You don't want to not know 0124 1 that there is a material claim but you're not interested in 2 having management guess what they may have to pay out to resolve 3 that claim. And I think that - that makes sense. 4 MS. CAMPBELL: Well, I'd like to know some - I mean, 5 I'd like to have an idea. I know that anything that they say is 6 going to be a guess. 7 MR. DOTY: Well, what do you want from the audit in 8 terms of what you all set forth as sort of the marker? That you 9 don't want the - you don't want the financial statements 10 performing the work of the analysts. What are you looking for 11 from the audit and the audit report that you don't now have? 12 What do you get from it that you need and that you like? And is 13 just after the fact retrospective irrelevant or is it something 14 that you would - you would what to have in order to make the 15 judgements even if you have more information directed from the 16 preparer? 17 MS. CAMPBELL: Joe, do you want to address that? 18 MR. LONGINO: It occurs to me just sitting here, and 19 people can add to this list if they want to because this is 20 just kind of of the top of my head, that there are about three 21 sources of uncertainty that I can think of with respect to these 22 questions about where does it go, the financial statement or 23 disclosures, what do you want from the audit and so forth and so 24 on. 25 The first source of uncertainty, I think, is the 0125 1 assets and liabilities themselves. And implicitly that's a lot 2 of what we've been discussing so far this morning and how you 3 value those. Whether you try to put a precise number on 4 something or give a range or just discuss it and disclosure, 5 rather than quantifying it in the financial statements. 6 The second source we've recently introduced in 7 talking about the contingent liabilities of litigation exposure, 8 and that is exogenous events. How is that going to effect 9 things. 10 If we go back to the first one for a minute, assets 11 and liabilities, for example, life insurance companies on the 12 whole would probably prefer to invest in long term assets that 13 have very little optionality. And the reason for that is, it 14 makes it easier for the to match those assets to the liabilities 15 that they're funding. 16 So that's the sort of question you get with respect 17 to the valuation of asset and liability items. 18 On the second, litigation exogenous events, I know 19 what's going to hap - we've seen what's happened to credit 20 spreads, for example, as a result of the whole question of 21 whether or not Greece is going to fall. Whether or not Italy is 22 going to be the second domino to fall. If it does, and we've 23 seen those sorts of things effect balance sheet items and 24 operations as well. And you've got the results of operations in 25 this mix also. 0126 1 And then the third thing is management. Management 2 is a source of uncertainty. We have better and we have less - 3 less good management teams. And companies are going to be 4 affected by how competent and present management teams are. 5 Ultimately what an analyst is passing a judgement on is not the 6 value of assets and liabilities, not even in a hedge fund or a 7 mutual fund, what you're passing judgement on is the 8 capabilities of management to negotiate the uncertainty of the 9 operating environment in order to enhance shareholder value. 10 And so, you know, I would view - I would view the 11 audit report as a - as a helpful check on - on - on what 12 management is - is saying in terms of inclusiveness in terms of 13 comparability insofar as that can be achieved. But much more 14 important than that is what the company discloses, how it sees 15 risks, how it manages risk. And the point of a lot of 16 disclosure is not comparability, the point of a lot of 17 disclosure is differentiation of management in its ability to 18 see risks in the way it approaches the management of risks. 19 And so I think where a lot of analysts find real 20 value in disclosures is differentiation among management teams 21 insofar as their capabilities are concerned; in foreseeing 22 events, in coping with them and rolling with the punches. 23 And so, you know, my expectations of an audit report 24 are relatively limited and modest compared to the substance of 25 what I'd like to see coming from management about it's view of 0127 1 all these things. 2 And I'll just see if Terri agrees. 3 MS. CAMPBELL: Yeah. You know I think that auditors 4 are in a really tough spot. You know, it's - to be in a 5 position where they need to second guess management is difficult 6 for, you know, management knowing that businesses better than 7 anyone else. 8 I'm also concerned about the liability aspects that 9 auditors take on with that because it's - it definitely impacts 10 behavior either of losing their business because they're - from 11 their client or lawsuits afterwards if - if things go wrong. 12 So I'm reluctant to want auditors to take on too 13 much responsibility beyond reflecting what is happening in that 14 company. Does that - do the assumptions that management - that 15 management are making is that reasonable - I mean, certainly, 16 you know, you look at it in practice, you've got the most junior 17 people are the ones that are on the ground doing doing the 18 grunt work on the auditing side. 19 And then you've got the - hopefully key issues that 20 come up, and let's say litigation is one of them, where it's 21 going to float to the top. You're going to have managing 22 directors looking at that and signing off on that after having a 23 discussion with the managements of those companies. 24 I'm reluctant to have their role go too far beyond 25 that. You know, it's - I don't think it's a clear answer, 0128 1 either, unfortunately, of then what do they disclose to the 2 marketplace. Because, again, I know that the liability just 3 gets blown way out of proportion if they show any doubt of the 4 numbers that's happening on the management side. 5 And Paul can solicit KPMG's view on that in terms of 6 being able to have commentary on how comfortable you feel with 7 the numbers 8 MR. MUNTER: Well, as you know, currently our 9 responsibility is to gather evidence to evaluate whether or not 10 the company is reporting its financial position, results of 11 operations and cash flows in accordance with generally accepted 12 accounting principles. And whether it has sufficient disclosure 13 about that information. And we have professional 14 responsibility. 15 We also have a responsibility to engage in 16 communications both with management and the audit committee on 17 the judgements that are most significant and where there is - 18 where different conclusions could be reached. 19 So we have - we have that process in play. I think 20 the question that Chairman Doty is asking is, what external 21 communication beyond what is done now should the auditor be 22 doing and should it be based on the information we've already 23 gathered or should it be based on some additional 24 responsibility. And I think that's a question far better 25 answered by investors than it is by auditors. But it is - 0129 1 MS. CAMPBELL: We'll take everything we can get. 2 Not that everybody wants to disclose that. 3 MR. MUNTER: Yeah. As you say, there are trade-offs 4 in terms of risk. There are trade-offs in terms of the 5 relationships that the auditor has with the audit committee, for 6 example, and the ability to engage in - in frank and candid 7 discussions with the audit committee. 8 So there are tension points and pros and cons to 9 those kinds of selections of audit reporting mechanisms. 10 MR. KROEKER: I think that poses a real interesting 11 issue. If you take something like goodwill. The enterprise 12 level of goodwill typically is, you know, some discounted cash 13 flow future revenues on a cash basis, future expenses, present 14 value based on a risk factor and you determine whether your 15 goodwill's impaired or not. 16 If you turn that around and ask an auditor to opine 17 on projections of the next 30 years of revenue and opine on the 18 next 30 years projected expenses, I think you'd maybe have a 19 different dialogue about whether auditors are really to the same 20 level of assurance comfortable doing that. But somehow we call 21 that the test for goodwill impairment. 22 And I think that's a tension we ought to continue to 23 explore. How is it we can get comfortable with that level of 24 uncertainty but if we did it directly -- which seems like it 25 would be much more useful to an investor. If really what we 0130 1 want to know is what is management's guess of the next 30 years 2 revenue, it seems much more direct to have a table that spells 3 that out as opposed to a goodwill impairment test that does it 4 indirectly. 5 I suspect that's why we want to know about goodwill 6 impairment because we want to know, is there a change to 7 projected future profitability, prospects of the enterprise. So 8 we do it indirectly as opposed to providing the direct 9 calculation. Because if you did the direct one, we'd be, well, 10 we can't audit that. 11 Again, it's probably an overstatement, but that's 12 part of the tension here. 13 MR. WALSH: I think what I expect of the auditors is 14 there's an ongoing dialogue with management as to the 15 sufficiency of your disclosures. And to the extent that that - 16 the disclosures aren't - aren't sufficient in order to describe 17 the financial statements or there's a contingency out there that 18 is - that is material enough to make the statements 19 misrepresented, I expect - well, I expect, first of all, the 20 auditor to convince management teams that they need to disclose 21 more. To the extent that they're unwilling or they can't 22 disclose enough or the uncertainty is so great that they're - 23 there is a serious question of going concern, then I expect to 24 see an additional paragraph. 25 Given the huge amount of uncertainty that we've seen 0131 1 over the last several of years, I would have expected there to 2 be more additional paragraphs describing some of the 3 circumstances that are out there. 4 MR. NEWSOME: So regarding the audit, you know, the 5 first thing - I don't know if it was the first but somewhere 6 along the way one of the things that came to my mind is, who is 7 or who are the beneficiaries of the audit? Right. If it's the 8 investors, then today's audit doesn't really do a whole lot in 9 my opinion. Yes, it's conformity with GAAP. You have an 10 auditor's statement which, you know, I scan just to make sure 11 there weren't any material changes, usually the third paragraph. 12 Internal control again, you scan it, check the box. 13 Now, if you compare an audit to an accounting due 14 diligence report, I will tell you that auditors are very capable 15 of opining on lots of things when they're paid to do that. I 16 look at those. And we're going to get one hopefully today, you 17 know. My team will start looking at a report. And so they have 18 a lot of capabilities, but, again, who are the beneficiaries of 19 the audit. 20 And so when I think about an audit, you know, 21 whether it's a public or private company, some of the things 22 that come to mind are where the areas of sensitivity, you know. 23 Are there balance items that are very volatile? In other words, 24 you know, different every single day out of the quarter and, you 25 know, somebody stopped the spinning wheel and on the last day of 0132 1 the quarter, here's the number. But it was never that number at 2 any other point in time during the quarter. Well, that would be 3 interesting to me. 4 You know, reliance on third-party estimates, you 5 know, valuation, goodwill impairment, actuarial reserves, 6 investment manager, third-party inputs into the balance sheet. 7 Those are all things I typically try to get a hold of that 8 auditors don't really opine on. 9 And then you go to the letter to the audit committee 10 or to the board of directors. I try to get that as well. And 11 there's interesting information there, right? Because then 12 they're reporting to the company, "Here's what we found in our 13 process," but you don't see that in the auditor's well. And so 14 if the investors are the beneficiaries, or the users, I guess 15 more broadly speaking, it would be helpful to think about the 16 audit in that light. 17 If I could go back to, you know I have a bunch of 18 comments but I'll limit them. Litigation came up. Reserves 19 came up or I guess litigation liability came up. And so, you 20 know, I heard a couple of times, well, you know, the company 21 shouldn't have to report it 'til it's pretty sure. 22 But I'll tell you, if I invested in the insurance 23 company that was on the hook, I'd want them to estimate it right 24 away and then I'd want to measure them against their ability to 25 estimate. 0133 1 So if you're a DNO writer, you know, and some large 2 pharmacompany got sued and it's all over the papers, you know, I 3 hear some people saying, oh, well, they shouldn't have to deal 4 with that issue until they know what the litigation liability is 5 or what they're going to pay. But what about the insurer and 6 the people that invested in the insurer? Well, there's a 7 different hurdle, I think, being, you know, weighed upon, you 8 know, for the insurer versus the company itself. 9 So I do think companies should estimate. Now, I'm 10 fully aware that once they estimate than the plaintiffs say, ha, 11 they're guilty and now we know what their reserve is so they're 12 going to go after it. So there are issues that I'm aware of. 13 MR. KROEKER: On that - just that one specifically, 14 is there a difference, and maybe there's not, in an investor's 15 view as to whether you've got a homogenous population so an 16 insurer taking on a broad population of similar arrangements 17 versus the, you know, idiosyncratic - you know, at least 18 potentially idiosyncratic litigation and obviously companies are 19 subject to both. They could be subject to, you know, ongoing, 20 you know, claims of warranty or other things versus more of a 21 lifetime event for a company. And maybe there isn't a 22 difference to investors. 23 MR. NEWSOME: What comes to mind is, I guess, the 24 relevance. Right? So when would you see it as an investor in 25 an insurance company? If it were the Exxon Valdez oil spill, 0134 1 you know, that's really, really big, right? And there are other 2 cases that were really big. And so specialty insurer, an 3 off-shore firm specialized in DNO, would have a significant 4 impact from that type of event. 5 And so I guess it varies a bit but, you know, 6 relevance, I think, is the - I guess one of the measuring tools 7 that you would use. 8 MR. GLOVER: Terri used the comment, auditors are in 9 a tough position. And I think, Chairman Doty, when you ask 10 about auditors, I think they're right in, square mack dab in 11 this - smack dab in this brittle illusion of exactitude. Why? 12 Because federally they're mandated to issue an opinion that 13 says, all the numbers in the financial statement are fairly 14 stated in all material or respects. 15 And it turns out when you ask at least a certain 16 group of users, given the uncertainty in the financial 17 statements, how big of a margin for error would you put on 18 pre-tax income? They say 95 percent, about five percent; plus 19 or minus five percent. Now, this group might say, now, that 20 might not be realistic. And it turns out it's not realistic 21 because of these uncertainties in the financial statements. It 22 isn't plus or minus five percent. 23 So even though some of these estimates are on the 24 balance sheet, the true ups - you think about the pension 25 accounting, end up flowing through OCI or net income. 0135 1 So technically we're asking the auditors to provide 2 a service that they probably can't do. In other words, they're 3 doing the best they can but there is not - there's a deficiency 4 noted in the PCAOB inspection reports for 2010 that said, the 5 auditor did not gather sufficient appropriate evidence because 6 when they got done, the reasonable range was six times 7 materiality. 8 Now, without knowing exactly what that was, what I 9 can tell you is, there is no amount of auditing that can 10 eliminate irreducible, inherent, un - you know, risk or 11 uncertainty. 12 And so you can't audit more to get, you know - if 13 you think about, again, pension accounting, you can change these 14 estimates by five, ten basis points when the experts would say, 15 the reasonable range is 50 basis points. And that's highly 16 material. 17 So you might think about in addition to the format 18 of the financial statements is, what's the right place for 19 auditors on these highly uncertain estimates? Can they estimate 20 - can they audit the process? I think so. I think you'd say, 21 did they follow a good, rigorous process? And can they audit 22 the range? Perhaps. Can they attest to that - the numbers were 23 already stated in all material respects which most people 24 interpret to say, fairly precise margin for error. Even when 25 they're doing the best they possibly can. 0136 1 The example of the deficiency, like I said, I don't 2 know. But for right now, today, in financial statements, there 3 are estimates that have a reasonable range, reasonable people, 4 experts would agree which are multiples of materiality. And no 5 amount of auditing can reduce it. 6 MR. DOTY: Well, one might think that our standards 7 should tell auditors how much work they should do to being to be 8 comfortable if they have a reasonable assurance if what 9 management has estimated is right. 10 I think that's the way our standards go. Our 11 standards really speak to what kind of work has to underly the 12 auditors becoming comfortable that they have sufficient 13 competent evidence - to confirming evidence to be able to get to 14 the opinion. 15 Beneath the question of how much investors expect of 16 an audit and what you want of an audit, is this lurking question 17 of whether you actually - since, as you say, it's a brittle 18 illusion of exactitude as the assembly found, do you want to 19 exclude that information from the fin - do you want the auditors 20 to put it aside and not report on it along with other areas of 21 uncertainty? Or do you want to rest with the assurance that the 22 auditors, unless there's a deficiency found in our inspection, 23 of course, that the auditors have done enough work to satisfy an 24 auditing and a test standard that they have a reasonable basis 25 for their assurance? I think that's a hard question 0137 1 So what's happened, though, is incrementally things 2 have changed because the PCAOB defined reasonable as high. And 3 then - yeah. That tends to be interpreted by the profession as 4 90 to 95 percent confidence. So we put the auditors in a spot 5 to say, technically we're attesting to something that is plus or 6 minus a very tight margin. 7 So I don't think we want to put auditors in an 8 impossible situation. What we say, is, what's the right amount 9 of evidence that would support a point estimate and what's the 10 reasonable range? Or right now when you read the standards, the 11 current PCAOB standards have been modified somewhat but they're 12 the legacy interim standards. The International Auditing 13 Assurance Standards Board and the ASB have convergence clarity 14 project. And they have just by one measure of comparison, twice 15 the guidance on auditing fair values. And they recognize that 16 there might be some estimates of things that we're talking about 17 that have a range of uncertainty that's greater than 18 materiality. 19 They say normally the auditors should be able to get 20 the range of uncertainty plus or minus materiality. 21 If - if you - I don't want this color group to bog 22 us down but if you will stipulate with me that there can be an 23 amount of work that can be done that will give them sufficient 24 competent evidential matter to have a reasonable basis, and they 25 can do it, the question that is interesting for us is, how 0138 1 valuable is that for investors and what are you willing to pay? 2 In other words, how much of the - how much of the resources of 3 the company are you willing to invest or do you think should be 4 invested in an audit to provide reasonable assurance on areas 5 that are inherently uncertain? 6 MR. GLOVER: Yeah. And I think we would agree that 7 as long as it's conveyed and the user can understand the 8 magnitude of the uncertainty and the auditor is able to assure 9 or attest to that, then I think we're on the same page. 10 Because I would guess if you were to ask this group, 11 and we ought to ask them, given that it's an impossible task, 12 how much do you want to pay the auditors to try to remove 13 uncertainty if it's not removable? Right? So if they can't 14 remove it, like you said, there's a reasonable range in which 15 they need to audit, but then stand back and say, some of the 16 numbers on the financial statements have extreme uncertainty and 17 maybe we provide the estimates and the inputs and we let the 18 experts determine what that looks like. 19 But this illusion of exactitude suggests that 20 they're not there. 21 MR. LONGINO: Let me just call attention to the 22 elephant in the room that we're - I think we're all aware of but 23 no one has specifically mentioned yet. And that's the trial 24 bar. This is a litigious country and society of sort unknown in 25 human history. And things that go on here are partly explained 0139 1 by that. The rules that we operate under here are such that 2 they're not necessary in other jurisdictions. 3 But a lot of what goes on out there by way of what 4 goes into the statements and what doesn't, what's disclosed. The 5 multiplication that Steve alluded to earlier of hundreds and 6 hundreds of footnotes and hundreds and hundreds of pages are 7 nearly a reflection of the fact that everyone is scared to death 8 and justifiably so of plaintiff's litigation. 9 And so I think that we can't - it's at least worth 10 mentioning that. It's not the subject or the topic of this 11 roundtable, but I feel almost obliged to trot that forward at 12 least to say, "There it is," because it's a factor. And it's a 13 very significant factor. 14 And I think related to that is a very interesting 15 transformation in the role of accounting and auditing that 16 probably began with the thrift crisis in the 1980s in this 17 country. Because if you think about accounting for a moment, 18 the basis of accounting, really, is bookkeeping. And 19 bookkeeping consists of transactions. And those transactions, 20 those payments, those receipts, gave certitude of a sort, at 21 least for a brief moment, as to what went into the financial 22 statements. 23 And what happened at the end of the thrift crisis, 24 as we got into the early '90s and the rubber was being cleared, 25 was that people looked back and some concluded that the problem 0140 1 with the thrift crisis was gains trading in securities 2 portfolio. That is to say, keeping the winners or selling the 3 winners, they had gains in them. And "portfolioing" losers. 4 Well, that was never anything more than a minor hiccup in the 5 history of - of - or the analogues of historical cost 6 accounting. The real problem was goodwill and supervisory 7 goodwill in the thrift crisis. 8 But that's a topic for another discussion. 9 The point here is that what FAS 115 did was to 10 severe the relationship between transactions and putting a value 11 on securities in the available for sale portfolio. And that at 12 least was tolerable because the securities involved were 13 securities that were traded in very deep and liquid markets and 14 really had market values. But since then, of course, you know, 15 we don't even have that. 16 Not only have we severed the basis to transactions, 17 but we also now don't even have liquid indeed markets for 18 valuing things like level three assets and liabilities. 19 It occurs to me that all this has come about because 20 consciously or unconsciously the accounting profession has been 21 pushed in the direction of becoming a shadow form of supervision 22 for banks, specifically, for financial companies generally and 23 it's ill-suited to be that. And I think that is a fundamental 24 problem that we're grappling with here. 25 It's a shadow form of supervision that tries to 0141 1 regulate financial institutions through the balance sheet and 2 the income statement, and more specifically, through the 3 calculation of shareholders, equity and profits. 4 And I think that's part - kind of the brief history, 5 if you will, of having gotten here. And this litigious 6 environment that we operate in this country doesn't help any of 7 that any. 8 MR. KROEKER: I think you left us speechless. 9 (Laughter) 10 MR. LONGINO: Is that an agreement? 11 MR. KROEKER: No. You know, I don't think that we 12 were intending to get into the trial bar or those aspects, but 13 what is it about, you know - certainly when you take things that 14 are more difficult to measure, to get to the economics of 15 substance. I think we'll start with, what is that investors 16 really need? And let's leave alone for a second whether or not 17 there are impediments to do that. I think this was really a 18 more simple question. And I don't mean to say that to be 19 unaware of other environmental factors, but I think we were 20 starting at - take something like a loan, there isn't just one 21 economic view. We heard that coming out of - loud and clear 22 coming out of the financial crisis that there are groups of 23 investors that say if a company can hold that and collects the 24 cash flows, and from their perspective things are no better or 25 no worse nor changes in interest rates. I'm going to collect my 0142 1 cash flows even though the market has placed a different price 2 on it. 3 Some saying, why wouldn't we focus on not showing, 4 you know show no change to the income statement? I don't feel 5 any different than I did the day before. And a whole group of 6 investors saying, it's not particularly helpful to them because 7 they do want to know what the market is pricing that at if for 8 no other reason than if the company is wrong and it's either in 9 its intent or its ability to collect those cash flows, say it 10 has to liquidate the assets. 11 So I'm trying to more modestly figure out what it is 12 investors are looking for as opposed to solving - 13 MR. LONGINO: Let me pick up something that came up 14 this morning on the part of one of the panelists. I'm having 15 trouble remembering which one but I don't think it matters. 16 The question was - or the suggestion was made that 17 different kinds of users have different needs. And I'm not sure 18 that's true. And I say that based upon my experience as a bank 19 supervisor here I Washington, D.C. In my distant past. And what 20 was important than in - really in the depths of the thrift 21 crisis was when I was in that job. And my recent experience for 22 about three years at Sandler as an equity analyst of banks. 23 And I really found that there was - there was not - 24 you almost couldn't see daylight between what had been important 25 to me as a bank supervisor and what was important to me as an 0143 1 equity analyst. I mean, the same sorts of things were 2 important; what's the operating environment like, what's the 3 capability of management; how faithful and accurate are the 4 financial statements; where does the company seem to be going; 5 is it going to wind up at the tender mercies of the FDIC or not. 6 Is it a going concern 7 So I would - if I understood the panelist correctly, I 8 take issue with that. And I think that there's a large 9 commonality of interests of various types of users of financial 10 statements. I just throw it out. I'm curious to know what 11 other people think as to whether you think that there are 12 significant differences or maybe any differences at all between 13 what some classes of users, supervisors, for example, investors, 14 need and expect out of financial reporting or not? 15 MR. WALSH: Yeah. Let me take a shot at that. As an 16 equity investor we're the lowest on the totem pole in terms of 17 our - we have the residual claim on the cash flows of the 18 company. And so I think to the extent that we get satisfied 19 with the level disclosure in the financial statements, I think 20 everyone else with a superior position should be happy. 21 So, if that helps. 22 MR. KROEKER: One of the issues, Gary, that you 23 brought up, and it was a part of Joseph's discussion as well, 24 was going concern. It's an area of interest, I think, to all 25 three organizations of what is the role of accountants, what is 0144 1 the role of financial reporting as it relates to going concerns. 2 I mean, it's clear today that the auditors have an obligation 3 when there's substantial doubt. I think the point earlier was, 4 you know, is that occurring frequently enough. 5 But I think this is another area of uncertainty in 6 financial reporting and what ought to be the role of financial 7 reporting in providing early warning? And then in particular, 8 is the accounting profession well suited to do that if we're 9 going to make projections about the viability of companies at 10 varying degrees? So, maybe, as opposed to substantial doubt, 11 some doubt, possible doubt. When you start to grade the 12 alternatives there, is that an area where financial reporting 13 ought to be doing more? 14 MR. NEWSOME: Well, one, investors differ so the 15 information that they use differs. I tend to like cash more 16 than GAAP earnings, for example, book values good from a 17 measurement or a relative evaluation standpoint, but at the end 18 of the day, whether you're getting equity dividends or, you 19 know, interest on your debt investment, cash is king. And so I 20 care a whole lot about where the firm, in my case mostly 21 financial services firms, are going to get the cash to pay 22 interest dividends and so forth; pay the bills, electric and 23 that sort of thing. 24 And so, you know, one example came to mind when you 25 were talking and so I will tell you I've been in, unfortunately, 0145 1 a few cases where there was a contentious negotiation, you know, 2 around year-end or shortly after year-end where creditors were 3 unhappy or there was a long, drawn out negotiation over an 4 amendment. And I think most people here know or should know 5 that an order will not give an unqualified opinion if there's a 6 heavily negotiated amendment that's incomplete. Right? Because 7 of the going concern risk. 8 I can't think of one case where that audit writer 9 said, unqualified but, hey, there's this long negotiation that 10 took place and we waited three weeks to issue our opinion. And 11 I'm not suggesting that they always necessarily should, but, you 12 know, think about the information that auditors have and who the 13 beneficiaries are of those statements. And then it becomes 14 quite interesting when you see the behind the scenes stuff that 15 goes on. 16 MS. CAMPBELL: I'm kind of adding to Mark's point. 17 I thought it might be - I don't know if you're all are aware of 18 this but if you look at kind of what has worked in stock picking 19 over time. You know, for a long period of time, '80s, '90s, it 20 was earnings revisions. So if a company came out and had this 21 price earnings beat, you saw - you saw out performance for that 22 for some period of time. 23 There started to be departure from that about ten 24 years ago where going off of earnings revisions as a way of 25 picking stocks became inefficient. It didn't work anymore. 0146 1 And what - what replaced it was basically free cash 2 flow yield. If you had a company that was increasing it's free 3 cash flow yield where there yield was higher than what people 4 were expecting that has been a good way to pick stocks over the 5 last ten years. 6 So, you know, kind of looking at the implications of 7 that is that, okay, then that means that investors have stopped 8 looking or valuing the earnings of the companies to such an 9 extent that it's not really working for stock picking anymore. 10 The uncertainty that has come of that is not where we're 11 spending our time. 12 I think that you can have a - you can take a lot of 13 - imply a lot of things from that without really knowing if 14 there's certainty to that. Does that mean that investors don't 15 have confidence in the net income number? Do they think that 16 it's - you know, it's arbitraged a way ahead of time? There's 17 all kinds of things that you can point to to say, well, what is 18 the problem. But regardless, the reality is, is that people are 19 concentrating on cash and that's been working for awhile. 20 And then it becomes, okay, well, if that's working, 21 then how much confidence do we have in this final numbers and 22 then that's where we all start to concentrate of, okay, if they 23 do have liabilities come up, do they have enough cash to meet 24 those liabilities. Where could things come from that aren't 25 expected that could potentially hit those companies? And if 0147 1 they have to start selling assets, where is that going to come 2 from? 3 So I'm just bringing this up because it's kind of 4 reflective of the change that's happened over the last ten 5 years. Again, it's just my personal opinion, but I think a lot 6 of it has to do with the uncertainty that's behind some of the 7 numbers that are being published now is the reason why we're 8 focused so much more on cash flow than we had in the past. 9 MR. KROEKER: It seems to be, and I don't know if 10 there's any disagreement, but one of the things that's been a 11 common theme is the linkage between earnings and cash. I think 12 Mark was it your earlier example where a company changed its 13 accounting on the revenue side to move further away from the 14 cash. So I don't know if - but one of my take-aways is, as we 15 think about accounting standards, the linkage between that 16 standard and how cash flow is generated. I think FASB - I don't 17 want to speak for anyone there. I see Marc can speak for him or 18 for them. 19 MR. SIEGEL: I can't speak for them. 20 MR. KROEKER: But we saw this, I think, in the lease 21 - on the revenue side of the lease project where, you know, if 22 you're going to say the obligation you incur in a lease is a 23 liability upfront, you know, one, if you thought the balance 24 sheets of the world should match, you might say, well, the other 25 side has the entity proportionally sold that piece of the asset 0148 1 under lease and recognized a revenue for that sale upfront. I 2 mean, that's one potential model. And I think some have heard 3 that maybe that separates earnings from cash flows and creates 4 uncertainty that might not be warranted in financial reporting 5 particularly if you're projecting lease renewals. And maybe 6 we're good enough reporting lease income as you receive it over 7 time. So that's one of the take-aways. 8 Maybe I'm missing that. That people are comfortable 9 in a number of areas where earnings reflect cash flow. 10 MR. SIEGEL: Actually, the lessee side is probably 11 even more of a stark contrast, right. If you have straight 12 rentals, straight rental payments going out, if a lessee model 13 that assumes that all leases are financings and has front loaded 14 interest rate - interest expense, would get further away from 15 cash, right? Because you'd have the amortization of the right 16 to use asset coming straight line. You'd have a mortgage - 17 mortgage amortization interest expense on this new lease 18 liability that would front load some of the interest expense. 19 So you'd get further away from cash. 20 But the boards, the majority of the boards, have 21 decided that that's more reflective of the economic in that the 22 decision between lease and buy should not drive an accounting 23 difference or a reporting difference. But it does get further 24 away from cash and that's something that's ben very contentious 25 for both boards for some time. 0149 1 MR. GLOVER: One follow-up to this conversation, 2 Joe. You said all the users want different information. It 3 seems like from this morning and today maybe, and maybe they're 4 different industries that don't feel like they're reflected as 5 well by one model or the other. So it could be as you're 6 thinking about - Marc used the example of should we provide 7 tables where everybody discloses things the same. I think you 8 can think of the financial statements as a form of table right 9 now. And maybe, you say, there are some other snapshots. And I 10 don't know if it was Terri's. What was the cash flow; the free? 11 MS. CAMPBELL: It's free cash flow, yield. 12 MR. GLOVER: So as you look at the different users 13 in industries, maybe there's no one model that best reflects 14 all. But we're trying to put everybody into a similar box. 15 Maybe everybody has to be in similar boxes and there's different 16 snapshots. One that reflects uncertainty. One that reflects 17 changes in assets. One that's more about cash. So maybe that's 18 part of it. 19 Some users might have different focus. Some 20 industries don't feel like they're well reflected. We heard a 21 lot about insurance this morning. So maybe not everyone is best 22 reflected by the current table form or the current form of 23 financial statements. 24 MR. KROEKER: You've done a lot of work on - 25 MR. SIEGEL: Financial statement presentation? 0150 1 MR. GLOVER: Yeah. Financial statement presentation 2 is a project that's been a long standing project from the board. 3 And right now it's - it's not as high a priority project as our 4 probably the four biggest priority ones between both boards. 5 But it is something that from a personal my view standpoint it's 6 something that I hear over and over again from investors that 7 thinking about the means of communications between management 8 and investors is - is something that we should be doing and a 9 high priority. 10 MR. KROEKER: And I think there was a lot of work 11 done in that project to think of how can you report that which 12 is maybe a great not - you know, not absent to all estimate, but 13 maybe on more solid ground separate from then accruals with a 14 separate column of mark - to market adjustment and a final 15 column that puts that all in and - 16 MR. SIEGEL: We've - we've done a lot of the - the 17 staff has done a lot of work on that, as Jim has described. 18 If you ever listen to former Chairman Hertz, he 19 would describe it as changes in flows, cash flows. Is something 20 that he felt was critical to the investor and sort of drives 21 that core earnings repeatable, this stuff that deserves a 22 multiple, if you will, as opposed to changes in stocks. Things 23 that maybe don't deserve a multiple. 24 Part of this, though, is that the boards don't have 25 an anchor, a common anchor today, on what the performance 0151 1 statement is supposed to look like. The FASB Concept Statement 2 5 is sort of a start. But I think some people, some board 3 members, think of the performance statement as just what are 4 these - this period's changes in flows, right? Just this 5 period's earnings, this period's things that are controllable by 6 management. And that's all that should be in the performance 7 statement. 8 Other people think of the performance statement as a 9 role forward from the beginning balance sheet to the ending 10 balance sheet. And maybe you have a net income number and a 11 comprehensive income number below it. But until both boards 12 sort of settle on whether they think the performance statement 13 is supposed to be in its entirety, it's hard to reconcile the 14 issues. 15 MR. GLOVER: And this is easy to make a suggestion 16 because I'm not there, but one thing that strikes me is, if 17 you're trying to get everybody to agree on one form, that's 18 really difficult. But if you're to say, there are different 19 constituents, different views, what if we had multiple views, 20 and then maybe you can get people to say, well, I don't like 21 view one but I do like view two. If you force me to only get to 22 view one, it's going to take us forever to get there. 23 So maybe part of the constraint is, we currently 24 think of a performance as this one form. Maybe there are 25 multiple forms. 0152 1 MR. WALSH: Yeah, this morning we talked about their 2 being an average of 250 pages, or so, in the financial 3 statements. If we just had one footnote that said, sources of 4 uncertainty, and we talked about any - anything that could cause 5 a materiality threshold to be violated, I think that would be 6 one footnote that I would read every time. 7 And I think some of those will be obvious, but I 8 think to know about the sensitivity to commodity price changes 9 or interest rate changes, systemic risks, some of those things 10 that - that as an investor you could go through and say, okay, 11 I'm comfortable with this risk. I'm comfortable with this 12 uncertainty. This one I'm really having some trouble with. 13 Maybe it would allow you to engage management in a useful 14 conversations as to how they get around or comfortable with some 15 of the risks they're taking. 16 Rather than having little bits and pieces scattered 17 throughout the financial statements, so that the attorneys can 18 say, well, yeah, you - it was right here. You didn't read page 19 whatever. I think that would be an improvement. 20 MS. CAMPBELL: So on the financial statements in 21 themselves, I mean, alarm bells go off in my head when I think 22 about major changes to the format. And this goes back to the 23 comparability issue that was talked about in the first panel, 24 because comparability is not just being able to look companies 25 within the same industry or across industries or across 0153 1 geographies. It's also about being able to see a company's 2 change over time itself. 3 And the number of changes that have happened so far 4 and the number of future changes that are being discussed, 5 should be recognized that that - you lose comparability every 6 time you have one of those changes. That it's, you know - if 7 you're looking at how a management behaves over a business 8 cycle, it takes a long time to go through a business cycle. And 9 you lose all of that information whenever you change things. 10 And I think that that's - that brings a full new 11 level of uncertainty to the process that's going to force 12 investors to go back to cash measures. Because when it comes 13 right down to it, if you don't know how it's - what's really 14 happening on it, then you start demanding to know what's 15 happening with the cash; what's coming in, what's going out, how 16 are they - how are they handling it. 17 And it's a big concern because it feels like there's 18 so many changes going on it's as if there's a belief out there 19 that if we just had the right number of changes that we'd get a 20 perfect system. And we all recognize, there is no perfect 21 answer to this. And there never will be because you have lots 22 of different companies and lots of different industries and an 23 environment that constantly changes. 24 So how do we better reflect those changes as they go 25 on, you know? It's concerning that there's big changes that are 0154 1 happening that I'm not sure they're addressing problems that 2 really exist to the level of the magnitude that it's going to 3 have in the longer term where people just lose confidence in the 4 numbers. 5 And I think that's reflected in both pro forma 6 numbers, the use of tangible book value. It's - you can pick 7 also different examples from different industries but it's a 8 real concern that we're kind of losing sight of what we're 9 trying to - what we're trying to really get to. I'm really not 10 sure where the impetus for changing the full format of the 11 financial statements came from. It's not any investors that 12 I've ever talked to. 13 MR. KROEKER: It came from investors. 14 MS. CAMPBELL: I know. I hear that. But I don't 15 know any of those investors. 16 MR. KROEKER: The CFIA Institute polled thousands of 17 its investors. 18 MR. SIEGEL: I'm one of them. 19 MR. KROEKER: Mark is one of them. 20 MS. CAMPBELL: Oh, you are. So you want to have the 21 change? 22 MR. SIEGEL: But - but - but - but -- just think of 23 this, Terri. You mentioned the cash flow statement and the 24 importance of the cash flow statement. One thing that as a 25 former investor, I mean, I obviously, I totally agree with that. 0155 1 The cash flow statement is all organized in terms of 2 sort of what Jim was alluding to earlier, right? A section that 3 deals with here's operating stuff and here's investing stuff and 4 here's financing stuff. 5 So one change that is - that is - that was on the 6 table is to disclose either on the face of the financial 7 statements or even change the format radically, but even absent 8 that, would you be opposed to just saying keeping the format of 9 the financial statements the same but putting underneath the 10 balance sheet, operating assets, investing assets, financing 11 assets? So you could do ratios, like, operating cash flow to 12 operating income to operating assets. Operate, you know, 13 investing to investing to investing. It's just to get some 14 cohesion so that you could actually do return calculations that 15 made sense. 16 And that - so from a radical change standpoint, I'm 17 not seeing it as such a a radical change. I'm saying, to take 18 something from the cash flow statement that everybody seems to 19 think is relevant, and applying it to the old statements. 20 MS. CAMPBELL: I'm curious, I mean - it's - I think 21 that, you know, it would be very interesting. But I'm also very 22 curious to see what the preparers think about that. Are they 23 looking at their own businesses that way currently? Are they 24 running their businesses that way currently? I don't think so. 25 And what do they have to do to change their process 0156 1 in order to provide that because I've become very concerned when 2 you start to have accounting departments within companies become 3 so large that it's overshadows what the underlying business is. 4 5 You know, I can say that somewhat from experience 6 with, you know, working for an insurance company. That you 7 spend so much time preparing these statements that are not 8 necessarily reflective of how companies are managing their 9 business. And I don't know what - what do the preparers say 10 about that? 11 MR. SIEGEL: The preparers more - the - the feedback 12 that we got from the preparers was more on the other issue which 13 it sounded like before you were in favor of which is a direct 14 cash flow statement. Because the other part of that proposal 15 was a direct cash flow statement. 16 MS. CAMPBELL: They were in favor of that? 17 MR. SIEGEL: No. 18 MS. CAMPBELL: Oh, they were not in favor of that? 19 MR. SIEGEL: No. Very much not in favor of that. 20 And we got less negative feedback about the cohesive 21 part of it, which is to say the idea of breaking it out. There 22 was some. There was some, especially around, you know, 23 completely changing the format of the financial statements, yes, 24 we did hear from preparers saying that's not the problem. 25 You're solving a problem that doesn't need to be solved right 0157 1 now with doing that. So, yes, we did hear that feedback. 2 MS. CAMPBELL: The only other - the other thing that 3 kind of pops to mind on putting either an income statement or a 4 balance sheet into terms of how the cash flow statement is 5 operating and investing in finance is that, is that the best way 6 to look at things? Is the cash flow statement itself reflective 7 - how reflective is it of the business, you know, when you're 8 adding back in the intangibles and - you know, there's a few 9 lines that we'll pay particular attention to and it's going to 10 be, okay, what is - what's the income less these non-cash 11 expenses. And the what are they spending capital - what are the 12 capital spent? And, you know, what are the big projects that 13 they're using money for. 14 But, you know, the cash flow statement is more than 15 a little imperfect. 16 MR. SIEGEL: So and one - maybe not directly related 17 to uncertainty but to the extent you're trying to follow cash 18 flow, one thing that would help avoid that, but there's been 19 tremendous push back in terms of it's cost, would be a direct 20 cash flow statement. I think it would be hard to say that 21 that's anything other than reflecting the actual cash flows. 22 So one of the problems now as you're backing out a 23 bunch of non-cash stuff to get to cash flows and invest - you 24 know, some investors have said it would be much more useful to 25 know cash collected from customers, cash paid to vendors. And 0158 1 so you don't have to deal then with the noise of - if you think 2 it's noise, the noise of non-cash expenses. Now, obviously, you 3 can hold back payments in the short term to make cash flows look 4 one way or the other or have a big press to collect on 5 receivables over short periods of time. But, you know, it's 6 pretty hard to say it's anything other than the cash going in 7 and cash going out. 8 MS. CAMPBELL: And I don't want to imply that it's 9 perfect either. I mean, I think you're looking at energy 10 companies as a prime example of that. Because they have huge 11 cash flows, variation on a quarterly - a quarter to quarter 12 basis. And they have problems with, you know, a point date as 13 well. It's going to depend on what the commodity underlying 14 price is and, you know, did that - did that tanker shipment get 15 delivered or not. 16 So I mean, again, I just want to bring this up, that 17 it's - I'm not sure that there's - there's not a perfect answer 18 to it. And it goes back to can we as investors have a good 19 understanding by what is delivered now of what managements are 20 doing and why and what's happening with the company underlying 21 and what can we do to improve on that, which is exactly the 22 whole point of all of this. 23 But it's - it does come down to, I mean, cash does 24 matter. And I don't think we've got a good way of tracking that 25 now as imperfect as it is. 0159 1 MR. NEWSOME: If I could give you a couple of 2 examples, which I know Mark you've heard me say before, but when 3 you talk about comparability -- and what I said earlier, some 4 investors look for different things, I'd proposed and advocated 5 the, you know, I guess deconsolidation of an income statement 6 between cash and accrual items. Right? Because some people 7 care about GAAP earnings per share whereas others care about 8 cash. 9 And you know that it does become wildly popular but 10 that is not a cash earnings figure either because it is accrual 11 and some of those accruals should be backed out and others are 12 reasonable because you're going to pay salaries in the next few 13 weeks or something like that. 14 And so I think that helps. And I guess the 15 background that I think about is, what, I guess, is what a 16 school professor called "the accounting continuum." At one end 17 you have cash. At the other end you have complete accruals but 18 over time all those accruals should reflect or convert to cash. 19 Right? And so what I care about is what do you have today to 20 pay that dividend or interest or bills and what are you going to 21 have tomorrow. Right? And then you get those ranges of 22 uncertainties. And so if you deconsolidate that income 23 statement, then people can kind of get both and it's never 24 perfect. I agree with you. But cash flow from operations has 25 all of these balance sheet effects which I don't find very 0160 1 useful personally whether it's financial services or a 2 manufacturing company. 3 And then the other thought that I had was almost 4 every company I've seen, so I presume almost every company has 5 its own internal management financial statements. And I can 6 tell you my experience is that companies that in my opinion are 7 in the same business have different management financial 8 statements and that's because, in my opinion, they manage the 9 company differently. 10 And so that's really where I get at with financial 11 statements is how are you managing it and how do you think about 12 it. And then as an investor I will make an opinion as to 13 whether or not you do a good job. At the end of the day, I 14 think that's the role of the statement is to help me understand 15 how management runs their business and what the financial 16 implications are. 17 MR. KROEKER: It struck me as you were talking about 18 accruals ultimately converting to cash. And I think that might 19 be at the heart of some of this discussion is the greater the 20 level of uncertainty you incorporate into accruals, the less 21 likelihood those accruals end up resulting in any impact in - on 22 cash. 23 So the more uncertainty, the less likely earnings 24 will over short periods of time reflect cash. 25 MR. MUNTER: Jim, I agree with that, but I don't 0161 1 think that means that the information is necessarily 2 uninformative. Right? 3 MR. KROEKER: I didn't suggest that. 4 MR. MUNTER: I mean, the example that comes to my 5 mind is accounting for post employment health care benefits. 6 For years and years and years our accounting model was pay as 7 you go. So obviously none of those costs were reflected in the 8 cash flows. The obligation wasn't reflected anywhere in the 9 financial statements and acknowledging that there's a lot of 10 uncertainty that goes into that measurement that ends up in the 11 financial statements. There are companies for which that is far 12 and away the largest obligation that they have. And is, I would 13 expect, pretty important information 14 for investors to at least have an idea about relatively how 15 significant that is. 16 MR. KROEKER: So I wasn't trying to suggest that 17 uncertainty is an excuse for not recognizing assets for 18 liabilities. And, of course, in that one probably less 19 uncertainty about whether they're going to pay or at least 20 continue to pay assuming they're a going concern. Maybe some 21 uncertainty as to the level, although there might be a very 22 clear and reasonable, you know - with high degrees of certainty 23 that the reasonable floor is, you'll pay at least as much as 24 today's health care rates. And, you know, things FASB struggled 25 with then is how much do you want to incorporate future 0162 1 assumptions as to whether, you know, the rate will look like 2 today's rate versus some future rate. And then if you're going 3 to present value that. There are even aspects of that that you 4 would say, things that are more certain than other aspects of 5 post employment benefits. But certainly not a reason not to 6 either capture or otherwise disclose including the assumptions 7 that go into it. 8 MR. STARR: Yeah. I'm going to take us back to the 9 beginning, if you don't mind. 10 When we started this initiative, when we started 11 thinking about what we wanted to talk about, we started looking 12 for things that we think put pressure on the final reporting 13 system; things that might be difficult for investors to 14 understand. Things that are difficult for - or challenges for 15 preparers and certainly for auditors. 16 And we looked at what we see as an increased extent 17 of measurement uncertainty in financial reporting. So as we 18 wrap up what I'd like to hear from this group is is there 19 concern on the part of investors about the extent of measurement 20 uncertainty in the financial statements in financial reporting? 21 How much should be recognized? In other words, have 22 we started recognizing too much and that's not useful? Are we 23 not recognizing enough and we need to be even have it be more 24 relevant? And what's the best way to communicate the extent of 25 the uncertainty in the financial statements? 0163 1 MR. LONGINO: Let me take a crack at that. 2 I think - and people can jump in even before I 3 finish talking if you want to. I think most investors are 4 probably not troubled by uncertainty in financial reporting and 5 disclosure. I'm using that comprehensively because I don't want 6 to just focus on the financial statements. 7 There's a lot of information out there. I think 8 that a lot of investors are concerned about, particularly in the 9 financial services space, is the ability of accounting 10 conventions to distort business judgements and to make it harder 11 for companies to operate and harder for investors to invest in 12 those companies because they are dragging into the financial 13 statements themselves amounts and degrees of uncertainty that 14 don't belong there because they're not relevant to the business 15 model. 16 In the joint project of the ISB and the FASB, for 17 example, to fair value 40-year insurance contracts, liabilities 18 through the earning statement on a quarterly basis, that doesn't 19 make it any easier to invest in good insurance companies. 20 In the ongoing deliberations of the FASB right now 21 as to how as to how to entitle securities to amortized cost 22 accounting, and the focus seems to be shifting to the question 23 of does the security have individually negotiated credit terms 24 like a loan, in which case it's entitled to amortized cost 25 accounting or does it not, in which case the answer is fair 0164 1 value. That doesn't really look at the businesses model of the 2 banks that own those securities, because a lot of securities in 3 the securities portfolio are like planting equipment. They're 4 there to generate recurring income. And their day to day or 5 quarter to quarter fluctuations of value are not terribly 6 relevant to the way the business is run. 7 So I - I'd hazard a guess that most investors are 8 not troubled by uncertainty and certainly most analysts I'm 9 including. They expect it. They know that it's there. They 10 know it's unavoidable. But they want to see uncertainty in its 11 proper place in financial reporting broadly considered. And not 12 have things in the financial statements that don't properly 13 belong there because in the end it just makes it harder for them 14 to invest and make money. 15 MR. NEWSOME: Maybe I can give you a couple of 16 examples instead of - and Starr wants just a high level thought. 17 So if you take banks a few years ago and for some 18 banks in the current environment, one of the things that crosses 19 my mind is some banks are relying on money market investors to, 20 you know, fund their operations to a degree. And we know that 21 some European financial institutions are having a hard time 22 acquiring dollars right specifically U.S. money market funds are 23 invested somewhat heavily in European financial institutions. 24 And so if that's the case, and have this pool of 25 illiquid loans which, may, in fact, collect as predicted, if 0165 1 they can't get new money market funds to invest in new loans, 2 choices have to be made. Right? And so they can say, well, 3 stop making new loans, which has future cash flow implications. 4 Right? Or they could sell some other stuff that they have to 5 provide liquidity to keep doing their ongoing business. 6 Or what if certain depositors say, you know what, 7 we're going to switch our money to somebody else because we 8 hear, you know, things aren't so good. Then how do we fill that 9 gap? Liquidity from some source, some other investor, or sell 10 stuff. Right? 11 And so you get this, I guess, crossing of, I guess 12 conflicting interest. Right? What are you going to do? And as 13 an investor, I don't think you really see that. You might hear 14 a general statement, the dollar market is, you know, difficult 15 or something like that. But you don't hear a lot about the 16 choices that have to be made. 17 For insurance companies, similarly, a lot of 18 insurers cash flow match where you have a liability that goes 19 out let's say 20 years and so you buy investments that go out 20 for effective duration matching. But if some of those 21 investments become illiquid along that continuum, then you have 22 to get the cash from somewhere else. Right? And so where are 23 they going to get it and what are the implications? 24 And so those are some of the things that I think 25 about with financial statements that's not really bridging the 0166 1 implications between one part of a financial statement and the 2 other. 3 MR. GLOWER: The question was, is there too much or 4 not enough uncertainty conveyed. And I think we can agree it's 5 an uncertain world. I think we can agree there will be some 6 uncertainties in financial statements. I think we might agree, 7 it's not easy to navigate. There's not a clear roadmap of where 8 the largest uncertainties are or how big those uncertainties 9 are. 10 So thinking about transparently conveying those. 11 One approach that's been suggested is different snapshots. 12 Instead of trying to find the perfect snapshot. 13 14 So reconsidering where those uncertainties are, 15 whether it's a footnote, as Gary said, that says, here are the 16 four or five most significant and here's how big they are or 17 it's a different view of a - different columns in a financial 18 statement. A roadmap where the uncertainties are and then the 19 disclosure of bigger, what's the reasonable range, I think would 20 be helpful. 21 MS. CAMPBELL: I'd echo a lot of what Steve said and 22 also what Gary said about having the uncertainties identified 23 and the concerns where they think they can have the biggest long 24 term impact. 25 And having it in a consolidated space so that you 0167 1 don't have to go through 200 pages and potentially miss it as 2 you're falling asleep through the 40th. 3 And the other, you know, piece of that is going back 4 to the transparency side of it is, you know, having historical 5 costs, having what the fair value is and having either 6 information of what that cash flow for those assets and the 7 underlying assumptions goes along way towards investors having 8 the tools that they need to kind of make a judgement call 9 themselves on what those underlying assets are. 10 Now, whether or not the preparers are going to be 11 able to do that or not is another issue. But, you know, for 12 myself I'd like to see what assumptions are being used, what the 13 cash flows are, so that then I can make my own judgement of 14 whether or not I agree with management. Realizing that we're 15 all dealing with uncertainty every day. 16 MR. KROEKER: Chairman Doty, Marc, do you have 17 anything else? Otherwise I find the remarks - 18 MR. DOTY: I took away four conclusions that I felt 19 were fairly startling. Not startling but influential. 20 One is that investors don't want to see the auditors 21 moved into a role in which the auditors aren't competent to 22 perform what they're asked to do. That is to say, a general 23 supervisor of management conduct or as a financial analyst. 24 On the other hand, investors would have thought the 25 public would have learned more from the auditors in the course 0168 1 of the recent financial crisis, as Mark Newsome. 2 On the other hand, the more uncertainty there is 3 injected in the financial statements and performance, the less 4 likelihood there that the financials are going to reflect the 5 cash of the company which just happens to be what people have 6 used to pick stocks successfully over recent periods. 7 And then finally the more uncertainty the less 8 precision, the more precision, the less relevance. 9 There's a lot to think about here. But I'm not sure 10 what the regulators do with it. I do think that some of the 11 things we were instructed to do as early as the assembly in 12 2005, which is to try to work together to see that we have 13 coherence and to be sure that we don't create in the public's 14 mind the notion that auditors are infallible or that the results 15 of financial statement is, you know, is certain. 16 If I'm wrong, you'll have to correct my associates 17 if I was wrong in what I took away. 18 MR. SIEGEL: The conversation has definitely opened 19 my mind to all the different aspects of uncertainty throughout 20 the financial statements irrespective of whether you have a 21 historical cost attribute or a fair value attribute. I mean, if 22 you just think about the asset side, and cash we talked about 23 this morning, having significant uncertainties potentially with 24 it. Inventory has a lower of cost of market threshold. And you 25 have inventory obsolescence for taxes. We talked about it. And 0169 1 just going down the line, investments, et cetera. Even cost 2 based investments have an impairment mechanism which is, you 3 know, market based and has assumptions and uncertainties 4 inherent in it. 5 And it gets back to something that Chris was talking 6 about earlier. These - you don't know at any given point in 7 time which is going to be the uncertainty that's going to drive 8 an investment decision. Cash becomes critical at different 9 points and an entity's business cycle. I mean, I remember 10 looking at a particular company where they had - the - you know, 11 the loan that everybody felt was going to be fine, the debt that 12 was going to be fine, all of a sudden the bullet payment was 13 going to be due and then the cash was stuck in a foreign entity. 14 And the issue that we talked about this morning of repatriating 15 cash at what tax rate and all this other, that was the issue. 16 Nothing to do with fair value. Nothing to do with anything 17 other than what is the restricted amount, what is the cash that 18 they actually have available to it. 19 And it gets to the ability to communicate those 20 kinds of uncertainties in the financial reporting package be it 21 in the financial statements themselves on the balance sheet, be 22 it in the footnotes or where MDNA has a lot of requirements 23 already for those kinds of things. 24 And, you know, the disclosure framework and anything 25 that comes out of this, I'm just encouraged that at least the 0170 1 three organizations are trying to think about this together 2 because it's not going to be a one - it's not going to be a 3 solution that's driven off of either - you know, one leg of the 4 stool, if you will. 5 MR. NEWSOME: If I could just follow-up on that, 6 Marc. One of the problems I've found over the years is the 7 difference between where the SEC governs, the reporting package 8 and the FASB governs it. And so, you know, I often flip back 9 and forth and, you know, you wind up searching through those 10 100s of pages of footnotes, going back to the MDNA and then you 11 call the CFO, how do I link these numbers, and, so, to follow on 12 that thought, you know, working together would be very, very 13 helpful. 14 MR. KROEKER: We're certainly committed to doing 15 that and particularly as FASB looks at their project on 16 disclosure framework, they already invited us to participate 17 both from an OCA perspective as well as a divisional corporation 18 finance who's spending every day looking at MDNA and filings. 19 So I think it's advice well taken. 20 Any closing remarks? 21 If not, we'll reconvene around - what was the plan? 22 3:45. Give you a last shot. 23 Again, want to thank the panel. The advice is 24 appreciated and we will - we have your contact information if we 25 want to follow-up, and you have ours. 0171 1 (Off the record) 2 MR. KROEKER: We'll go ahead and get started for the 3 third panel of the day. 4 Once again, very thankful for the volunteers and the 5 participants. I look forward to a discussion on the third panel 6 that maybe we'll focus a little bit more on the challenges from 7 the standpoint of, or the opportunities from the standpoint of 8 accountants and auditors. But we certainly want to also, then 9 as we have that discussion, a perspective of investors to say, 10 well, given those challenges or not withstanding those 11 opportunities we still think you ought to do this or to do that 12 to assist investors in their financial analysis. 13 But I think a good opportunity to continue the 14 discussion. 15 So I'd like to welcome Jay Hanson, a PCAOB Board 16 member who will, along with us, moderate this panel. 17 And maybe given what we've heard, and for those who 18 haven't had the benefit of the discussion throughout the day, I 19 think there's been a robust discussion of the broad topic of 20 uncertainty and really trying to capture that in one or two 21 sentences, I think, is fairly difficult. Except that I think 22 it's clear to say that every one of the panelists have 23 recognized that uncertainty is not going to go away. And it is 24 something that is critical to investors analysis that I think as 25 a system we can do a better job of providing that information to 0172 1 investors. 2 So I'd really be interested in the perspective of 3 the group, how can we better - maybe the same question Mike - 4 and I won't get the words right - 5 MR. STARR: I'll correct you. 6 MR. KROEKER: That you asked toward the end of the 7 second panel is, not withstanding the opportunities and 8 challenges are there thresholds that we ought to be looking for? 9 I wouldn't say as a mutable thresholds but what are the types 10 of items where uncertainty is best captured in financial reports 11 and on the statements themselves. What are the types of 12 uncertainty or items where there needs to be additional 13 disclosure and/or uncertainty should be expanded upon or 14 captured in a company disclosure around financial statements. 15 I'll say for now whether that's best captured in footnotes or 16 it's best captured in MDNA. 17 But I think that would be one of the things that I 18 think would be particularly useful to all of us would be are 19 there, sort of, guide posts that people ought to be looking to? 20 And then likewise, whether or not as we do that, should there be 21 differentiation? I think Chairman Doty brought up the idea of 22 differentiation in terms of expanded audit disclosure or 23 differentiation on the balance - I don't know if he brought this 24 up, but I think it came up - with differentiation on the balance 25 sheet or in financials of these things are more susceptible to 0173 1 uncertainty than those things. 2 So really a broad discussion. And I would open it 3 up with, can you help us define those things that are better 4 captured in measurement and recognition and those things that 5 are better captured in the footnotes or broadly in disclosure? 6 MR. GALLAGHER: Jim, to that point, I mean, it was - 7 I found it interesting this morning on both panels, there seemed 8 to be a consensus, you know, conceptually that obviously the 9 more uncertain the less interested they were in having it being 10 captured in the primary financial statements. 11 And while the information was valuable, you know, it 12 seemed like they'd rather - investors would rather see more of 13 that in the footnotes rather than in the primary financial 14 statements where you have the susceptibility of the movement 15 from period to period that was so subjective that they felt was 16 not helpful. They'd have to take out to come up with you know, 17 to fit their models so they could do their evaluations. 18 You know, I guess intuitively that made sense to me 19 and I understood it. But it was just so clear in some of the 20 fair value discussions and some of the other ones. 21 And I just go back to my experience, you know, 22 working with chemical companies that had asbestos exposures. 23 And why you would always come up with a number. The only thing 24 you knew for sure about that number is that it was wrong. And 25 that the value in the disclosures was so much more than whatever 0174 1 you put into the financial statements. 2 Now, obviously if it tripped up debt covanance I 3 mean, it could be very important when it went into the financial 4 statements. But in terms of understanding the impact, cash 5 flows, which we talked about a lot this morning, too. 6 Those footnote disclosures are just so important and 7 whether you can capture a number, discounting the cash flows or 8 discounting the numbers that are in the footnotes, just the 9 qualitative disclosures in the footnotes, if it was done right, 10 was just incredibly valuable to investors. 11 So, you know, I'm not sure that helps in terms of 12 saying, what should be in the footnotes versus, you know, the 13 financial statements. But clearly as you move along that 14 continuum of, you know, uncertainty and the fact that it could 15 fluctuate based upon things that were not observable in the 16 market. You know, obviously it gave investors great pause in 17 terms of whether that should be in, you know, the primary 18 financial statements. It seems like they thought it would be 19 much more valuable in the footnotes. 20 MR. BASKIN: My concern with the panel has been that 21 the investors we've had on the panels are not typical investors. 22 I don't think they're the typical banker reviewing - who looks 23 at financial statements and tries to make a loan decision. I 24 don't think they're the typical personal investor. I - I am 25 concerned with their recommendation about just give us a table 0175 1 in the footnotes and we'll make our own adjustments. That most 2 people can't do that. 3 And don't find the table in the footnotes that list 4 out each of the assumptions and the range of assumptions and the 5 assumption used. They don't find that very useful information. 6 And so my concern is that the views we've heard so 7 far on this roundtable are not necessarily representative of 8 most users of the financial statements. 9 And that takes me to the concluding point, which 10 would be that I think the uncertainty that exists in all of the 11 financial statement balances and amounts needs to be reflected 12 in the balance sheet and in the income statement and in a 13 summary fashion so that it is visible. And I think it's not 14 known today. It's not known how one company's uncertainty 15 compares to another company's uncertainty. And the magnitude of 16 the uncertainty is not known today. 17 And so my big concern is that the answer for most 18 people is not to give me pages and pages of tables in the 19 footnotes. It's put the information on the balance sheet and 20 the income statement. 21 MR. KROEKER: Just as a follow-up. Does that lead 22 you to some balance sheet that would then disaggregate between 23 more certain amounts and more uncertain amounts? Because those 24 investors, likewise, if you say -- would give an appreciation 25 for the difference in uncertainty between enterprise. A level 0176 1 three asset that's on the balance sheet at a million dollars is 2 going to look very similar to cash in the highest rated 3 financial institution's deposit account. Of course, they both 4 sit there at a million and that doesn't convey anything about 5 the level of uncertainty inherent in the measure. 6 MR. BASKIN: Right. Or even worse than that, they 7 don't sit there at a million. They sit there at a 1,387,432. 8 MR. KROEKER: Right. 9 MR. BASKIN: Which gives the appearance that they 10 are precise within a dollar, when they're absolutely not. And 11 that is even worse. 12 I think that certainly there is a range of 13 uncertainties. I think there's - there should be a threshold 14 for making those uncertain - making those more uncertain amounts 15 known. Perhaps at the - around the materiality threshold. And 16 that - that those uncertainties need to be displayed and 17 reflected in the summary totals in the financial statements so 18 that you can see what that means to the uncertainty in the 19 bank's capital or what that means in the uncertainty in our 20 bank's per share. 21 MR. KROEKER: Bradley and then Janet. 22 MR. HUNKLER: Thanks, Jim. 23 MR. KROEKER: We'll just go around the table. 24 MR. HUNKLER: Everybody's got their pent up comments 25 from sitting through the earlier session. So - 0177 1 I think if you look at uncertainty as sort of the 2 enemy of objectivity and you say the objective of financial 3 statements or the goal of financial reporting should be to have 4 as much objectivity in the financial statements as possible. 5 And then you start to look at that uncertainty on the continuum 6 and you say, how far along that continuum do I go knowing that 7 the further I go the less objective my financial reporting is 8 going to be. 9 You know, the question becomes, what's the right 10 stopping point? I mean, I work in an industry, the insurance 11 industry, where we're already starting pretty far down that 12 continuum of uncertainty because generally that's our business 13 is we accept your uncertainty and you pay us a premium for that 14 as part of the risk model. 15 But where we think the right stopping point is, is 16 very much of what I would call sort of the business model 17 analysis. We really look at the business model as sort of the 18 primary driver of where you determine - at what point do you 19 accept uncertainty in the financial statements and at what point 20 do you require objectivity in the financial statements. 21 So if your business model is one that would require 22 what I call significant trading activities or - or - you know, 23 we generally know in our industry or we'll estimate, you know, 24 I'll cash value today and we estimate what a cash settlement 25 value's going to be in the future. And as we go down the time 0178 1 continuum, you know, we may change an estimate based upon those 2 expected cash flows. But there's lots of other variables that 3 change during that period of time, including interest rates, 4 discount rates, the values of our assets, liquidity in the 5 market. 6 So, you know, I think it certainly makes sense to 7 reflect changes in estimates around those cash flows but it does 8 not make sense to reflect changes in estimates on things like 9 the discount rate and potentially liquidity considerations if 10 it's not our business model to trade those liabilities. 11 So that's where, I think, the business model has to 12 play a role because other institutions and other industries may, 13 as part of their business model, part of their strategy, may 14 revolve around trading those assets or trading those liabilities 15 and as such, you know, bringing in sort of the periodic 16 fluctuations that may occur and the market forces that may 17 impact those values. And the uncertainty around those market 18 forces may be more pertinent but in other industries it may not. 19 So I do think business model needs to be part of 20 this discussion. It needs to be part of the solution. I know 21 it currently exists in certain FASB statements. And it has been 22 brought up during the discussion on the debate on insurance 23 contracts. 24 So at any rate, I think that needs to be a big part 25 of the determining factor around how you move down that 0179 1 continuum around uncertainty. 2 MS. PEGG: I feel like I should start off just with 3 a comment that I'm not a typical analyst as an accounting 4 analyst. I mostly focus on the accounting side of it, but in my 5 25 years, I've probably worked with hundreds of analysts so I 6 think I'm right next to them in a lot of this. 7 And with that, I think I agree with Bradley's 8 comments, except I would change it just a little bit. Rather 9 than business model, I think when you think about how much you 10 want to depend uncertain numbers, it really depends upon the 11 relevance of the information. That to the extent that you're 12 looking further up the income statement or on more important 13 items on the balance sheet, you would like more certainty in the 14 numbers. There's some understanding that that might not always 15 be available. So my belief is that at that point that's when 16 disclosure has to come in to try and fill in the void. 17 I personally would never want to see any number not 18 appear on the income statement. I think that if we had a full 19 statement of comprehensive income there's a place for this 20 information. And in this day of proforma earnings and 21 reconciliations back to GAAP or whatever, there's a lot of 22 information there that people use in different ways. 23 So once you put it in a footnote, it just doesn't 24 get the prevalence and the importance that it does when it's on 25 the primary financial statements. 0180 1 MR. KROEKER: Liz, then Kevin. 2 MR. GANTNIER: Gosh, I have so many thoughts from 3 listening to the earlier panels. 4 I mean, some of the things that I've taken away from 5 this is that really the investors and the auditors are all on 6 the same side. And I wasn't sure of that coming in here today. 7 But what we would have some very different views of things. And 8 quite frankly, after the first two panels, I think, our views 9 are very similar on a lot of stuff. 10 As to the question at hand. I think one of the 11 things that was loud and clear was that estimates are only 12 valuable when they're valuable. And that there are plenty of 13 places in the accounting literature that sort of demand 14 estimates that ultimately people think are irrelevant. And it's 15 sort of disconcerting to me that I've spent an awful lot of 16 audit time, budget and effort on auditing goodwill and goodwill 17 impairment to be told that we throw that number out. 18 And I would be the PCAOB inspectors when they come 19 in, if I had said, "Gosh, we thought that was irrelevant and we 20 didn't pay attention to it," would disagree. 21 So I think there needs to be some natural 22 understandings between all of the parties as to what's relevant 23 and why and that differing businesses will have differing pieces 24 of relevance. 25 I also think one of the things that I heard was that 0181 1 back in the day, depending upon how old you are is when that day 2 was, but back in the day accounting was relatively simple. And 3 that you knew what was wrong with the number. If it was at 4 historical cost you knew that that may not be accurately 5 reflecting fair value today and you understood that. And so you 6 could make your own assessment as to how to change that number 7 in your head. 8 I think accounting has spent a lot of effort over 9 the last ten years to make the numbers more reflective of a 10 current day value as opposed to historical cost value. And at 11 some point you cease to know now what's wrong with the number. 12 So if goodwill is going to be rate-ably impaired over 40 years, 13 well, then, we know what's potentially wrong with that 14 assessment because it's being amortized. But if goodwill is 15 being adjusted due to the superiotic impairment tests that are 16 really very complicated and subject to a tend of estimate and 17 assumption, we now don't know what's wrong with that number 18 anymore because we don't potentially have enough disclosure 19 about the estimate and the assumption. 20 So without good disclosure, it don't really much matter 21 what's on the numbers themselves. Without good disclosure about 22 how you came up with that number, where in that number there is 23 sensitivity and, you know, a wide range. Without all that, the 24 numbers don't matter. 25 MR. SPATARO: Thank you. And thank you for the 0182 1 opportunity to participate. 2 I wanted to really make two comments here and 3 observations. 4 The first that I wanted to - observation I wanted to 5 make is that I think that the SEC both in Courtfin and OCEC, I 6 think that you have it just about right in terms of where you 7 are in terms of accounting requirements and disclosures. 8 If I look to what the requirements are in terms of 9 risk factors, in terms of the critical accounting estimates, in 10 terms of the general MDNA requirements, and I look at my own set 11 of financial statements that I prepare and I look at the other 12 financial statements that as an investor that I review, I think 13 that the disclosures are very robust. 14 I think that the individual that was here from 15 Courtfin earlier today, I think she was right on the mark 16 because she said something to the effect of, you know, we 17 operate in a dynamic environment and what tends to happen is 18 that we build up disclosures in reaction to events. For 19 example, the credit crisis. And so we had, you know, ten, 20 twenty, thirty pages, depending on the relative size of your 21 organization, in investment disclosures and then those just tend 22 to stay there. And they don't burn off, you know, any time - 23 any time quickly because once a disclosure is added, it 24 typically takes a long time for a company to determine that it's 25 no longer material information and then they take it out. 0183 1 So I think that - her point was a good one is that 2 maybe what needs to be done maybe we're not in a bad place but 3 maybe we do need to in this constant dynamic environment always 4 redetermine what are the, you know, internal and external risks 5 that were exposed to uncertainties and so forth and determine 6 whether or not those types of risks are being adequately 7 addressed and disclosed as opposed to some of the other, you 8 know, time and effort that's being spent carrying forward 9 disclosures that investors are no longer placing reliance on. 10 So I think that in terms of, you know, where the SEC 11 is, I think that - again, I think that you about have it right. 12 13 And then we go back and I answer the other question. 14 In terms of uncertainty in the financial statements, from the 15 perspective of an insurance company, there are already - and 16 I'll link it back to the previous statement - there are already 17 items in the balance sheet that are subject to uncertainties. 18 So when we measure reserves, that is - that doesn't have, you 19 know, an exact amount that's associated with it that has a - you 20 know, that has a number of estimations and assumptions that go 21 into the development of that. 22 And so what we do is we marry that up with a good 23 comprehensive disclosure within the critical accounting 24 estimates of how we come up with those disclosures. And we also 25 talk about if, in fact, you know, our estimates were different, 0184 1 what impact would that have had on net income. 2 And so I think that, you know, in that respect I 3 think, again, we have it about right. And I'll make one other 4 comment and this is more of a forward-looking statement about 5 where the insurance contracts project is going with the ISB. 6 Now, that's a totally different - you know, that's 7 going down a different - a totally different path about bringing 8 more uncertainty into the actual measurements. So one of the 9 proposals there - and it's not been a proposal of -- at least 10 short duration contracts of the FASB, is to include risk 11 margins. And so then the question becomes, is that an element 12 of uncertainty I now want to incorporate into the balance sheet 13 measurement? And do I think that that ultimately will aid 14 investors? 15 We in the U.S. have said, no, we don't think that it 16 will aid investors. We actually think it will, you know - it 17 will make financial statements less understandable, less 18 comparable and less transparent because just as one company 19 that's gone through the testing and attempted to apply those 20 risk margins, the multitude of judgements and assumptions that 21 are inherent in developing those risk margins and together with 22 the decision of the IASB, that they would not only give you 23 three different methodologies, but actually open up to any 24 different methodology one would potentially want to use for 25 calculating those risk margins. There's not enough pages in a 0185 1 set of financial statements to provide the level of reasonable 2 disclosure that a financial analyst would need to understand 3 changes not only in a company's financials but to compare it 4 even across the industry and across geographies. 5 So I think that that's one where if you ask the 6 question about how much uncertainty do I want to incorporate, 7 that probably crosses the line of that's an uncertainty that I 8 don't think would be beneficial to preparers, investors or any 9 other users of the financial statements. 10 Thanks. 11 MS. GROSS: I'll kind of go back to what I think 12 Janet and Liz commented on. I think it fundamentally gets back 13 to what's relevant. Given the business model, as Bradley was 14 talking about, and what's relevant to the users of the financial 15 statements. 16 You know, from the panels we heard this morning, I 17 think there was a loud cry that we need some more robustness in 18 the disclosure. That that's the opportunity for management to 19 tell their story to, you know, add some more robustness around 20 methodologies and assumptions that the context within which they 21 made their decisions. And we heard a cry for a roadmap. So I 22 think there's a role, whether that's a single footnote or, you 23 know, auditors emphasis paragraphs or something that can help 24 direct the reader of the financial statements to what are those 25 most critical estimates that were made; the ones that were 0186 1 highly subjective where it could have a significant impact. 2 That it's relevant to the business model that they're operating 3 under. 4 And then provide more robust disclosures, whether 5 that's sensitivity ranges or more qualitative discussion. But 6 direct the traffic to, you know, the few pages that are highly 7 significant and important to that company versus, you know, the 8 200 other pages of footnotes. 9 MS. GANTNIER: I'm sorry. I'd argue that that's 10 already there through either the critical accounting policies or 11 through the summary of significant accounting policies. And 12 that, perhaps, we're not doing a good enough job in fully 13 articulating the level of uncertainty as we go through either 14 the critical policies or the significant policies. 15 But what concerned me about having one foot that 16 sort of covers all these basis is that you're not eliminating 17 any of the other footnotes that are already covering all these 18 bases. 19 And so we're going to end up with, you know, a 20 multiple set of places either in the CAP or the summary 21 significant deposit or back in the actual footnotes themselves 22 where we're discussing the same thing. 23 So I think we have a mechanism already to do what 24 they're asking to do. Perhaps we need to better articulate in 25 those policies the uncertainties and where to go look for either 0187 1 the range analysis or the sensitivity analysis or the discussion 2 of the assumptions themselves individually. 3 MS. GROSS: And I would agree with that. I mean, I 4 there's an opportunity to rationalize the process and to 5 eliminate some, you know, redundancy between footnotes and MDNA 6 and to focus the attention where it's really important. But I 7 kind of agree with what you said about, I think, the SEC 8 observations earlier today. There's a lot of guidance there. 9 And we have - you know, around critical accounting policies and 10 some flexibility to handle it in a way that's meaningful to the 11 operations of that company. We just need to take better 12 advantage of that. 13 MR. KROEKER: One of the things I thought I heard 14 but if I didn't or if this group disagrees, while that's there, 15 better linkage between how that information then ties to 16 economic value or are these numbers that only an accountant 17 could love? How do these numbers - how does the uncertainty, 18 how does the disclosure about ranges of estimate then tie into 19 real world value that here's investor why you should care. And 20 I don't necessarily when you look at accounting policies and 21 critical accounting policies always see that translation to 22 here's investor why you should care. 23 MR. CZARNECKI: As the corporate board member, odd 24 man out here on this panel and chairman of an audit committee, I 25 will tell you that everything that the investors want and need 0188 1 are things that those audit committees and board members need. 2 And theoretically, we have more information than 3 what's disclosed because theoretically we're getting information 4 because we're supposed to have the governance oversight over 5 what's going on. And quite candidly, the aspect of the 6 commentary about the multitude of disclosures, some of which are 7 mind bending and only an accountant could love, are, in fact, an 8 important part of the challenge here is that, I think the reason 9 we're hearing investors say, I want you to talk to me about 10 uncertainty in some kind of a pocketed location is because 11 they're not finding it in these other footnotes in a way that 12 they can as investors process. They're seeing it in accounting 13 jargon. They're seeing it in the accounting rules. But they're 14 not seeing it in the context of information they need to tear 15 the financials apart and look at the business model, as you 16 described. 17 And candidly, I think that from our standpoint as 18 directors, our biggest challenge is, and frankly management's 19 biggest challenge, because I've spent a large part of my career 20 in that role as well, is then need information to be able to run 21 the business. And it's not necessarily the information that's 22 presented to the investors or presented to the investing public. 23 They all, every management everywhere, has its own internal 24 system for evaluating how its managing its business. 25 And those kinds of information are actually the 0189 1 information the investors are looking for. And what we've not 2 been able to find is a way for that information to find its way 3 into the investors so that the investors can understand it 4 without compromising the confidentiality of the business model 5 that somebody's trying to run. 6 So I think that this really is a significant issue 7 is if we start talking about taking in increased uncertainty - 8 an I'm chairman of an insurance company board of directors. The 9 bottom line is, that there - when I first about two or three 10 years into my chairmanship, all of a sudden I had this great big 11 gestalt. And all of a sudden the most important numbers on the 12 balance sheet were estimates. Except for the cash and 13 investments that we had, the most numbers that were on the 14 balance sheet were estimates. And all of a sudden I started 15 paying attention to those estimates in a very different way than 16 I did before. Shame on me for not figuring it out sooner, but 17 it became a really relevant part of my job as an audit committee 18 chair to make sure that I understood those numbers and 19 understood how they got there and how we communicate them. 20 I suspect that the average investor, looking at 21 those numbers, really doesn't completely understand how those 22 estimates get there. And because they don't, that's what 23 they're crying out for; help me understand. 24 MR. BASKIN: If I could, I think we, as accountants, 25 are really straining at this whole notion of disclosing 0190 1 uncertainty. And we don't have a history and culture of doing 2 it as exists in science and engineering and medicine and even 3 sociology. Where disclosing measurement uncertainty, and the 4 way to disclosure measurement uncertainty, is very clear. And 5 the rules are very clear. And we are - we've been kind of 6 dancing around this as a profession for a long time trying to 7 avoid actually disclosing the actual measurement uncertainty by 8 putting in narrative, by putting in discussion of how we do it 9 rather than simply doing it. 10 And I - in preparing for this, I went back to the 11 beginner's guide for uncertainty measurement put out by the 12 national physical laboratory. And I thin it's very interesting 13 that it says, every measurement is subject to some uncertainty. 14 A measurement result is only complete, only 15 complete, if it is accompanied by statement of the uncertainty 16 in the measurement. 17 And I think we're guilty for a long, long time of 18 producing financial statements that are simply incomplete in 19 that we put a point estimate in the financial statements and 20 say, that's the number. And it's an incomplete measurement. It 21 is simply incomplete information. 22 And so we have - I think have to start at the first 23 point by saying if the trial lawyers are the first elephant in 24 the room, the second one is that we've been producing incomplete 25 information for a long time. And we're just comfortable with 0191 1 it. Whereas if we were chemists or physicists or engineers, we 2 would be freaking out at the methodology of precision that's in 3 the financial statements. 4 MR. CZARNECKI: But in order to be able to do that 5 you need probabilistic theoretical constructs. In order to make 6 uncertainty actually work, that's what - is that what you're 7 talking about? That you would actually start applying 8 probability theory to the creation of the financial statement? 9 MR. BASKIN: Not probability theory but statistical 10 theory to it. Yes. 11 MR. CZARNECKI: Same thing. 12 MR. BASKIN: But there are other ways of evaluating 13 and describing the range of uncertainty than using statistical 14 theory. But you can do it through statistical theory. And the 15 way of doing it has been established in sciences for a long, 16 long time. We simply haven't picked it up. 17 MR. HUNKLER: Just another thought on the where 18 question on uncertainty. I think sometimes we generate - we 19 associate uncertainty with things like fair value measurements 20 for level three assets and some of these things when - when, you 21 know, realistically, you know, for a marketable security, you 22 know, an equity security or for a a liquid corporate bond, you 23 know, there's more uncertainty in a cost measurement basis than 24 a - than a market value basis. 25 And I guess, you know, what we - if you focus too 0192 1 much on uncertainty as the decision point for a basis selection, 2 you end up in a discussion that maybe doesn't make a whole lot 3 of sense. 4 So, again, that's why I kind of turn back to the 5 business model approach and say, you know, what is the business 6 model and you select a cost basis if that is your business 7 model. Or a fair value basis if that is your business model. 8 And you assess the level of uncertainty in that measurement and 9 determine if the value from the relevance that's created from 10 this selection that criteria outweighs the cost or the 11 sacrifice. 12 As we think about the construct of the financial 13 statements, we tend to think about a single measurement basis as 14 being the ultimate basis for - the perfect basis for measuring 15 that asset or liability. Occasionally, we don't like that 16 answer and so we use OCI as this kind of dumping ground for the 17 parts of the measurement basis that we don't like. And, of 18 course, the ISB has kind of started to back off and say, we 19 don't like OCI, we can't define it. 20 I guess what I would suggest as a concept is whether 21 or not the objective of the balance sheet and the objective of 22 the income statement are the same. You know, some would suggest 23 that the balance sheet is a measurement of management's 24 stewardship of its assets and liabilities. And the income 25 statement is a measurement of management's performance. 0193 1 And if you assume that those things might not result in 2 the selection of the same basis for an asset or liability, 3 that's where OCI can play a role where fair value may provide 4 balance sheet relevant information but cost may provide more 5 performance based income statement information. 6 And so that hasn't been properly articulated and it 7 doesn't really work through the standard setting process. And 8 what you get as a result is sort of this dumping ground model 9 where OCI really doesn't make a whole lot of sense and is 10 generally dismissed for purposes of analyzing a company's 11 financial statements. 12 So, again, as it relates to uncertainty, you know, I 13 guess I would suggest what - what I'm trying to say is, it's 14 more around basis selection and the level of uncertainty that 15 might come with that. So - 16 MR. GALLAGHER: So I would never challenge Dorsey, 17 who is obviously done the basic research that is far beyond what 18 I've ever dreamed of coming into today, but I - I - and I think 19 conceptually you're right about, you know, being incomplete. 20 The fact that there is uncertainty associated with far more than 21 we might be talking about today. 22 But I think a lot of that, investors and other 23 players in the capital markets, have absorbed. They understand 24 it. They get it. And this is a continuum. And I think, you 25 know, as we move towards the continuum and where I would draw 0194 1 the line, and I think Bradley had it right, is, you know, I 2 think there's uncertainty in economics, there's uncertainty in 3 the business and management, you know, through the business 4 model deals with that every day. And to the extent that they're 5 using uncertain measurements, you know, to the extent that the 6 accounting reflects that so investors have a sense as to the 7 measures that are important in running the business, I think is 8 a great place to draw the line. 9 I think disclosures are really important as you move 10 along that continuum, you know, because I think that there is a 11 danger that Dorsey talked about. You've got these incredibly 12 precise numbers, if you look at them carried out to the n'th 13 digit, and they imply a degree of precision that's not there. 14 And so disclosure around, you know, as you move along that 15 continuum where you are in that uncertainty, recognizing it is a 16 continuum. 17 I was very pleased to hear some of the investors 18 earlier today get that to a much greater extent than I thought 19 they did. 20 And then I'll just go back to disclosure because 21 there was a discussion around, you know, do we have enough 22 disclosure. Is it in critical accounting estimates, other areas 23 of MDNA, or is there more that can be done. And can we do a 24 better job of plain English, were a few of the thoughts that I 25 heard. 0195 1 I think the answer is, yes, we can move - prepares 2 and auditors can do a better job in term of plain - in terms of 3 plain English in working on disclosures collaboratively. And 4 what's going to be useful to investors. 5 I think the projects that the PCAOB is looking at in 6 terms of auditors reporting model, and specifically the two that 7 I would point out that the profession has gotten behind is, you 8 know, association with MDNA or elements of MDNA to raise the 9 level of compliance with some elements that we're talking about 10 today; management's judgements and estimates. It's right on the 11 money. And two, emphasis of matter paragraphs because the 12 financial statements have gotten so unwieldy. 13 You know, just pointing out that you really need to 14 look at this disclosure or that disclosure and by doing that I 15 guarantee you the dialogue between the auditors, the audit 16 committee and management will go up, you know, relative to those 17 disclosures. If you're pointing them out in your report, an 18 auditors report, everybody's going to make darn sure that those 19 disclosures are best in class. So I think there's an 20 opportunity there. 21 And, Mark, to your point earlier, you'd mentioned it 22 a couple of times, the disclosure framework could not be more 23 important in terms of, you know, high impact on the capital 24 markets and focusing on what is the framework as we think about 25 disclosure related to uncertainties and streamlining it rather 0196 1 than having - you know, each of the standards have their own 2 individual disclosure requirements that aren't necessarily 3 synced up. So I think that's a great opportunity. 4 MR. HANSON: Well, I think I agree with about 57.275 5 percent of what's been said here, just approximately. 6 One of the topics that came up in our auditor 7 reporting model roundtable a few weeks ago, to your point, 8 Dorsey, about who are the - who are the financial statements 9 for? And are they written for, I'll call the proxy Aunt Mable, 10 or are they written for the most sophisticated investor that 11 really wants to know the details so they can deconstruct the 12 financial statements and reconstruct them using their own model. 13 I think as one of the former Courtfin directors who 14 is reasonable for a lot of the rules, and make no mistake, I 15 think it's for the sophisticated investor. It's not for Aunt 16 Mable. 17 But that's a fundamental question, I think. It's 18 important to put on the table of - of who are we trying to write 19 these disclosures and - and - both the MDA an the financial 20 statements for, because it's very different in terms of the 21 approach you might take. 22 One of the things I reflect on from this morning. 23 I'm trying real hard to figure out, how do we give investors 24 what they need and ways that they can use it? Personally, I 25 don't think more disclosure requirements are the answer. I 0197 1 think we got plenty of disclosure requirements. As Meredith 2 pointed out, we got so many things at MBNA. So many things in 3 the financial statements. The hundreds of pages. I think 4 people want the clarity to simplify it down so they can 5 understand it. 6 And one of the things I heard this morning was the 7 concern about the uncertainties this whole thing is involved. 8 I'm thinking, gee, if there's a way to construct a financial 9 statement that instead of - I'll call it the industrial-age 10 balance sheet, ranked in order of liquidity from cash on down 11 through fixed assets for a commercial company, ranked in terms 12 of uncertainty. So it was some - some - almost like the buckets 13 of the fair value levels, some buckets of the uncertainty in the 14 entire balance sheet. 15 And the other thing I heard is the volatility of 16 those numbers is very important. Is that number - the number 17 that's reported only that number on that data and it varies 18 widely? That if there was some way to rank the balance sheet in 19 terms of volatility that would provide meaningful information to 20 help the investors out. I don't know how we do that, but that's 21 - that's - that's something I think for - for you to think about 22 in the in the model for what the financial statement - mythical 23 financial statement in the future is going to - going to look - 24 look like and within the constraints today, though, of the - of 25 the disclosures. And I know it varies widely by company, by 0198 1 auditor, that the exercise of filling out the 295 page 2 disclosure checklist that Ernst and Young or PMBC or Grant 3 Thorton puts out is - by necessity has to be a compliance 4 exercise, but I think the best companies step back and reflect 5 on, does the story that's told through these disclosures really 6 reflect the best story in a concise way. I'm not sure that 7 everyone is doing that consistently. And there's a wide range 8 that can be fixed in that front without doing anything. And the 9 same thing with tying that together with the MDNA. 10 MR. SPATARO: I just wanted to say a couple of 11 things. 12 I think that, you know, we do need to be careful in 13 terms of moving to measuring uncertainty and including it within 14 the balance sheet amounts. I say that in connection with the 15 project - the insurance project that the ISB is currently 16 working on. Because in essence what they've done is they've 17 come up with a building block approach where you use probability 18 weighted cash flows. You discount them and you add in a risk 19 margin. 20 And it sounds great, but what I would say in that we 21 all need to take a step back is that all of the models that 22 anyone can construct over the last ten, twenty years, nobody's 23 cracked the code in terms of how to predict the future. 24 So, you know, if you would have gone back in July or 25 August of 2008, you would have sat down with chief risk officers 0199 1 for companies that are no longer with us that would have said 2 that with a 95 - within a 95 percent confidence interval, that, 3 you know, their capital could have withstood, you know, any type 4 of, you know, potential - reasonably potential market event that 5 could have occurred. Until, of course, the market event that 6 they didn't model because they didn't know because it was 7 uncertain and because it was un-knowable occurred. 8 So I think that, you know, we do need in some 9 instances to take a step back, recognize our own failings our 10 own, you know, capabilities to predict the future and we also 11 need to consider how the existing tools that we have, how they 12 may be adequate combined with the appropriate amount of 13 disclosures. 14 So you go back to, you know, some of the common 15 terms that have been used today in terms of the business model, 16 and then also in terms of, you know, what we disclosed in the 17 critical accounting estimates and then in the critical 18 accounting policies. 19 And I think there is where we should focus our 20 attention. Is there information about uncertainty that we think 21 is deficient in how we talk about how certain of these items 22 when we even mentioned should we rank them. I think that if 23 you're looking at an insurance company, a property casualty 24 insurance company, you know, you would rank your reserves as 25 number one in terms of variability. 0200 1 And so if you rank that as number one in 2 variability, then I would say you should also go back if you're 3 a public - if it's a public company, go back, then, to the 4 critical accounting estimates. And then - and confirm that that 5 is the longest, you know, passage in the critical accounting 6 estimates that there's a discussion about what all of the risks 7 and uncertainties are in all of the estimates and judgements 8 that underly the computation - the periodic computation of 9 reserve balances. 10 And if at the end of that, you know, analysis you 11 say, well, you know what, I think that that's still deficient, 12 then I would say that that's where we need to focus our 13 attention. Is that we need to build up, you know, more rigor 14 around the information that's disclosed around the estimates. 15 I would also, as I said before, I would caution, in 16 terms of, you know, trying to introduce new methods of, you 17 know, of estimating uncertainty and including that in the 18 balance sheet, because I think that in many respects that's an 19 inexact science. And I'm not sure that it's better than what we 20 do today and I think that going back to what Brad and others 21 have said, it's also not consistent with the business model, you 22 know. 23 In essence, what we've talked about before, even 24 internally, after having done a field test of the - of the 25 building block model, is that fundamentally it's just not the 0201 1 way that we run our business. 2 So in essence what we would end up with, is we would 3 end up with a - thousands of people at my company, All State 4 Insurance Company, running the business like they've always run 5 the business. And then a handful of accountants and finance 6 people in the corporate office doing this financial overlay that 7 would come up and compute the risk margins and would do that 8 solely for financial statement reporting purposes but not for 9 how we actually run the business. And the reality is, is 10 because of the way that that business is run, even after you 11 would compute all of your risk margins and do all of your 12 discounting, it would be impossible to then push it all the way 13 back down into the field into the people who are actually doing 14 the estimation so that they could use it on a regional basis to 15 actually do their job. 16 So then the question is, is that who are then to 17 answer one of the questions that was asked before who are we 18 really then providing this information for and what is the 19 usefulness of it? If it's so, you know - if it's so divergent 20 from the way that you run your business and it can't even be 21 incorporated into the management of the running of your 22 business, what is the value of it? 23 MS. PEGG: I'm going to do a bunch of, "I agrees." 24 We'll start off with the audit opinion. I really think 25 investors would benefit from an expanded audit opinion. I admit 0202 1 it's a different topic but I think it would help investors 2 understand the complexities and the uncertainties in a company's 3 financial statements. 4 I also will agree that it would be wonderful if we 5 could somehow tie all of the information in financial statements 6 together. Right now I spend a lot of time looking at pensions 7 and I have to look in the risk factors. And I have to look in 8 the critical accounting policies. And I have to look at 9 contractual obligations. And I have to look at summary of 10 significant accounting policies and then finally get to 11 pensions. So and try to pull that altogether. 12 I also want to agree that investors are definitely 13 concerned about trying to look to the future. So with that, I 14 would also say that sometimes we get a little too conceptual in 15 trying to design things. And we come up with this beautiful 16 model that is so opaque that the information that people get 17 isn't very useful to anyone. And with that opaqueness, you 18 can't sit there and say, well, if interest rates do this, or if 19 there's a hurricane or if there's some other event, what's going 20 to impact, because I don't understand this beautiful model and 21 all of the pieces that go into it. 22 So sometimes - I tell this to the analysts a lot 23 when they're trying to do models - is that, you know, you can 24 spend a lot of time coming up with a beautiful model that isn't 25 very useful. 0203 1 So sometimes we just need the information. And a 2 lot of disclosures to understand 95 percent of what's going on 3 there, but at least it's going to help us in trying to figure 4 out what's happening tomorrow. 5 MR. KROEKER: So as you say that, I wonder - and I 6 don't know that this has come up - but whether there's some 7 skepticism, not that investors expect accountants to predict the 8 future, but there's skepticism that accountants might know more 9 about uncertainty than is being conveyed. So that there is, you 10 know, this veil of this is really uncertain but maybe it's not 11 and more can be provided. 12 Or do you think investors are looking for - you 13 know, if it is a quest for tell me what's going to happen in the 14 future, it seems more likely to not see eye to eye. 15 MS. PEGG: I don't think that's the case because I 16 think when investors think about accountants and the financial 17 statements, they're looking at it from the historical 18 standpoint. And they really are trying to focus on the next 19 period, the year after that, and not much further than that. 20 So I think they really just want to understand the 21 inputs and the variables and the degree of variability I those 22 numbers in order to try and go forward. 23 That said, they need a solid foundation to start 24 with. If it's a soft number to begin with, then they're not 25 going to be able to do much predicting as to what's going on in 0204 1 the future. 2 So it goes back to my relevance that I think if you 3 have an item that's maybe in operating income, we need a high 4 level of certainty, preferably in that number, at least a lot of 5 disclosure, to support the information. 6 MR. BASKIN: If I could, Jim, just react to a couple 7 of things. 8 One, is I think we have to be very careful, and it's 9 very difficult, to separate measurement uncertainty from 10 volatility in the amount we're measuring. And we typically 11 quite often confuse the two. And so what I'm talking about, 12 about measurement uncertainty has to do with - that as of that 13 measurement date, on whatever basis of accounting, whatever 14 basis of measurement is being used, that - that the number being 15 measured could be within a range that is reasonable. 16 That's the measurement uncertainty. And that is 17 entirely different than what may happen in the future and what 18 that liability may turn out to be. 19 The difference between what was measured and what it 20 turns out to be is not measurement uncertainty. Measurement 21 uncertainty is about the measurement date. What are the range 22 of values that might reasonably be measured at that date on 23 whatever basis it's being used at that date. 24 But I like to come to the auditing, because I - I 25 wish that - that we had gotten further with Dr. Glover and Mr. 0205 1 Doty on the last panel about this issue about whether the 2 auditor is being asked to give assurances at a level that are 3 not achievable. 4 I believe - I agree with Dr. Glover that we are. 5 I'm not sure how to solve that. I - I don't think - personally 6 don't think adding to the audit opinion to describe the 7 uncertainty in the financial statements is necessarily the right 8 thing. Right now, there is provision in the auditing standards 9 that would say to me that I could identify an uncertainty that 10 is more than material and qualify the audit opinion for that. 11 Now, I can't do that for the SEC. The opinion would 12 be rejected out of hand. But that is the only way, right now, 13 in the auditing standards that I'm allowed to deal with the 14 uncertainty that's greater than materiality. And, again, with 15 issuers I can't even do that. 16 So I think we're not - we need to start with a 17 solution in the financial statements, but we need - we need an 18 answer in the auditing standards that doesn't currently exist. 19 MR. HANSON: And Dorsey, we do have a couple of 20 projects on our standard setting agenda to deal with some of the 21 fair value measurement issues. And most of you are aware that 22 we have this pricing source, this task force, which is dealing 23 with one slice of it related to financial instruments that are 24 mostly fitting into level two bucket of the unfair value 25 hierarchy. 0206 1 And one of the meetings that we had, we asked a 2 couple of the pricing services, as well as another investment 3 banker, to give us their values of a portfolio, just 20 4 securities, ranging from those that we would expect to have very 5 little variance in that value to ones that -- highly structured 6 products, very little liquidity. And as expected, very small 7 range within a couple basis points at the - with the actually 8 traded - not actually traded but easy value to - to a very wide 9 range. And we're trying to - figure out lessons learned from 10 that to give some better guidance. 11 I full well appreciate that the exercise that the 12 preparers as well as auditors go through as often is not "is 13 this number right," but "am I okay that it's not wrong." And 14 personally, I don't sleep very well if not ever feeling like the 15 number's right. But just feeling kind of boxed in, know I'm not 16 wrong. In that - and finding a way to better communicate that 17 uncertainty through the financial statements so investors 18 understand that there is no single right answer to many of the 19 numbers. It's - It's what is the range of what it could be. 20 And I guess in a perfect world, showing what's the high, what's 21 the low and where's management? Theoretically somewhere in the 22 middle. But that would add far more complexity to add that to 23 even a single measurement, much less the hundreds of thousands 24 of individual securities held by some of the largest 25 institutions. 0207 1 MR. KROEKER: Mike then Liz. 2 MR. GALLAGHER: A couple of points. I agree with 3 Dorsey's first point around the difference between volatility 4 and measurement uncertainty. I think what frustrates investors, 5 what I heard this morning, was when you have both together, 6 where you have something that's extremely uncertain and it's 7 volatile. You know, for example, litigation. Not that that is 8 - you know, potentially could have, you know, marked to market 9 on litigation. I think that would have frustrated people. In 10 terms of going back to Bradley's point, no one would ever run 11 their business that way in terms of coming up with a precise 12 calculation. This is what my book of litigation is worth from a 13 conceptual standpoint, quarter to quarter, and mark on that and 14 potentially depending on how assumptions changed and how it 15 progressed, you know, having meaningful movements to your P&L 16 based on that. I think, you know, if we're looking for a line 17 to draw, that would certainly be where, you know, one of the 18 things I'd put on the other side of the line. 19 But just thinking about how measurement uncertainty 20 and volatility how they go together, I think is important in 21 figuring out where that line might be. 22 The other point around Dorsey that you mentioned 23 that under the auditing standards, you don't have the ability 24 short of qualifying the opinion. I think you do under today's 25 standards even before the project that the PCAOB's working on, 0208 1 you always have the ability to put an emphasis of a matter 2 paragraph in today and say, if you don't do anything else, you 3 know, make sure you read footnote "x." Right? You have the 4 ability to do that, right? 5 MR. BASKIN: Well, you can put in the emphasis 6 paragraph, but the problem with that is what you're doing is 7 disagreeing with your own opinion, in effect. Because you're 8 saying -- in this emphasis paragraph you're saying, although my 9 opinion says that everything is materially correct, there are 10 these numbers in footnotes 5, 7 and 16 that very well may not be 11 within the balance of materiality of the number that's in the 12 financial statements. 13 MR. GALLAGHER: I don't view it that way. I would 14 view it as, you know, the financial statements - the opinion 15 stands but there's - in terms of understanding the financial 16 statements, it's very important that you, you know - that this 17 footnotes is perhaps more important than others. So important 18 that you really need to look at it. 19 MR. BASKIN: Well, but what we're really saying is 20 we're giving negative assurances on that information. We're 21 saying that not positively that number is within the bounds of 22 materiality. We're saying nothing has come to my attention to 23 cause me to believe that it is not - 24 MR. GALLAGHER: I just don't agree with that -- 25 MR. BASKIN: - stated in - 0209 1 MR. GALLAGER: - interpretation of the literature. 2 MR. BASKIN: Well, if the number itself cannot be 3 stated with is more uncertain than materiality, then how can 4 the audit opinion - 5 MR. GALLAGHER: First of all, I don't think the 6 opinion is an expression of value. I think it's an expression 7 of compliance with - with GAAP. If it were an expression of 8 value, then there are things that aren't recognized that would 9 be equally as challenging. For example, unrecognized 10 intangibles. 11 So I don't think the auditor's opinion is an 12 expression of value with respect to individual assets and 13 liabilities. 14 I think it's, again, expression with fairly 15 presented inconformity with a standard that is generally 16 accepted accounting principles that within that has differing 17 outcomes or differing measuring - measurement basis for 18 different assets and liabilities. 19 MR. BASKIN: Well, I don't think then, Jim, you've 20 ever been inspected by the PCAOB on any of your audits. 21 (Laughter.) 22 MR. CZARNECKI: I think one of the things that I 23 think we're that's important to keep in mind is, is that -- 24 that we are talking about reports that go to investors but have 25 to go through management, the audit committee and a board of 0210 1 directors before they get out there. And the points you're 2 making about what's material and what's not and having an 3 auditor opine, in essence -- the sound I'm hearing is the 4 auditor will opine on the quality of the representations have 5 been made, not that they're in compliance with, but we have an 6 opinion about what - what you see here. 7 And I personally am uncomfortable with that. As a 8 director, that's our job to make that judgement. And it's not 9 the auditor's job. Now, I rely on the auditor to give me 10 guidance. And I ask the auditor a lot of questions about things 11 that I don't understand or that I think need to be pursued, but 12 it's my job as the chair of the audit committee and my job as 13 the director to be the one who makes those opinions about 14 management. To the extent that we bring in the auditor to make 15 opinions about the financial statements in the context that 16 you're - that I think I hear drifting, that basically changes 17 the role of the director and changes the role of the audit 18 committee. 19 Now, I'm not saying that the investors can 20 necessarily be absolutely delighted with how every board and how 21 every audit committee has performed. But I actually believe 22 that we've substantially changed the process. And the audit 23 committees and directors, and everything else, that's wrapped 24 around it has changed the way audit committees and directors 25 behave. 0211 1 So I would not be comfortable, as a director, to be 2 asking my auditor to give an opinion to the investors about how 3 well we did. I'm not comfortable with that. 4 MS. GANTNIER: I'm going to go back a little bit in 5 time to some of the things, Jay, that you talked about about 6 perhaps reevaluating the statement of financial position and 7 ordering it in order of precise to uncertain. 8 You know, I think all of these things are fair game. 9 And that really the reporting ought to be based upon what the 10 user needs for that company, for that industry, as opposed to 11 everybody's got to fit the one mold. And the one mold works 90 12 percent of the time for everybody and doesn't work at all ten 13 percent of the time for anybody. That kind of scenario. 14 But one of the gentleman this morning talked for a 15 long time about comparability. And so you're going to trade 16 usefulness for comparability when you do that. And so, you 17 know, perhaps, you know, we can all agree that there would be 18 one standard and then you're invited to use whatever mechanism 19 you want outside of the financial statement opinion. And you 20 can - you can create and present whatever is the most useful and 21 you're going to be rewarded for that because your investor in 22 Aunt Mable will understand it and really appreciate it and like 23 it. So I think we ought to allow some of that. 24 But my second feeling about this is, we've got to 25 distinguish what's financial reporting and what's financial 0212 1 analysis. And are we opining on financial reporting or are we 2 opining on financial analysis? I would prefer, me personally, 3 to have the financial statements and the footnotes be financial 4 reporting and let the rest of the document be the financial 5 analysis. And that we allow some latitude in the financial 6 analysis so that people get the analysis they really want as 7 opposed to the analysis you say they should have. 8 So let the market sort of reward a company for good 9 financial analysis and good financial reporting at the same 10 time, but sort of let the market decide what is necessary and we 11 continue the discussions of non-GAAP and things like that, so 12 that the reader is not confused between what's reporting and 13 what's analysis. 14 MR. KROEKER: That's one, I think, that strikes me 15 particularly when you're doing with good will. Is are we doing 16 financial reporting or where does financial reporting turn into 17 financial analysis when you're trying to figure out the 18 hypothetical value of either the enterprise or a segment that 19 incorporates, you know, what would this trade - particularly a 20 segment. What would the segment trade at if the segment was 21 separately trading. And then comparing that to recorded amounts 22 of goodwill. 23 And I don't know that there's an easy answer to that 24 but it really strikes me that we're blending - we're blending 25 the two. 0213 1 MR. SPATARO: I think that you both made a couple of 2 really good observations. I want to build on a couple of things 3 that Liz said as well. 4 Is I think that we really do need to focus on what 5 are the needs and what are the desires of investors. And so I'm 6 going to just give you just a little bit on, you know - of an 7 example just in terms of the insurance business. 8 And it also goes back to how does the company run 9 its business and how does it make money. 10 If we look at the business model of the typical P&C 11 insurance, it's all about underwriting. And all of that is done 12 on a gross, discounted basis. And so, in essence, if we look at 13 what's now being proposed as an accounting model by the IASB, is 14 that accounting model would have probability weighted cash flows 15 that we don't use. It would have discounting that we don't use. 16 And it would also add risk margins that we don't use. 17 So these are things that they would impose even 18 though it's not used to manage the business. And the reason why 19 it's not used to manage the business is because in terms of risk 20 margins, we don't believe that we can predict the future. We 21 think that it makes much more sense, at least in terms of the 22 way we run our business, to, you know - to do the underwriting 23 on the front end. And then, you know, match up on, you know, 24 our reserves to patterns of pay outs of similar reserves over a 25 suitably long period of time. And we've built up, you know, 0214 1 significant, you know, historical databases. And we present 2 that information on a statutory basis right now. 3 I think one of the, you know - one of the people on 4 the earlier panel said that they supplement their analysis of 5 both banks as well as insurance companies with statutory 6 financial reports. 7 And so there's ample statutory information to 8 actually show or prove how good management's estimates have been 9 over a fairly long period of time. And you can actually look at 10 what that variability is. 11 In terms of discounting, we've had folks that have 12 said, well, you know, you ignore the time value of money. But 13 we do only for a base - a very basic fundamental reason is that 14 if you drag the investment results into the estimation of 15 reserves, you've now taken two fundamentally different 16 operations of the business, investing and underwriting, and 17 you've mashed them together. And from an investor's 18 perspective, going back to the views of investors, investors 19 have said, we don't want you to do that because when we look at 20 your company, we want to look at your underwriting results. 21 That's how we value you. We don't want to have this volatility 22 moving through your financial statements on a, you know - on a 23 periodic basis that's solely attributable to changes in interest 24 rates. We also don't want to have all the added complexity of 25 all of the additional judgements that you're now going to 0215 1 include into the financial statements in terms of the amount and 2 timing of the payment of claims. 3 We just want to have it in the most basic - we'd 4 like to have it presented in the most basic terms. 5 And what they've suggested is that, that is the way 6 it's most understandable. That is what's most transparent to 7 us. And then when we get into the, you know, uncertainty, I 8 think, then, that takes us back into the financial statement 9 disclosures. That takes us back into the CAE. And that once 10 we've developed those measurements, if those happen to be gross 11 undiscounted measurements on the face of the balance sheet, then 12 the investors have said, well, we do want to have an 13 understanding, you know, of actually how you do your reserves 14 and what that potential variation is. And that takes you back 15 to the critical accounting estimates and that also brings you 16 back to the footnotes. 17 So I would suggest that, you know, again, focusing 18 on the business model, focusing on what the needs and desires of 19 investors are. And in terms of providing information about risk 20 uncertainties, I think that there are ample places in the 21 financial statements to do that. I think that, you know, as one 22 preparer, I would say that it's adequately done today. And to 23 the extent that, you know, investors don't think it's adequately 24 done, then, you know, they'll punish you, you know, by no longer 25 investing in your stock. 0216 1 MR. HUNKLER: I just wanted to get back to the 2 question that Jay had around Aunt Mable and who are the 3 financial statements designed for. 4 And in my mind, it's very clear that you really have 5 to design the financial statements around the sophisticated 6 investor. I mean, companies, large companies are complicated. 7 Accounting is complicated. I don't think you can take a full 8 set of financial statements and put it in a format that would be 9 necessarily readable to, you know, somebody that doesn't 10 understand the industry or the business. I don't think it 11 should be the objective to do that. 12 That being said, though, if you produce something 13 that is so complicated or so counter-intuitive that you can't 14 make any sense out of it without deconstructing it and building 15 it back up, then you've failed. If I sit down with Aunt Mable 16 and I'm looking at two companies quarterly financial results and 17 one of them lost two billion and the other one made four 18 billion, and I ask her which company had the better quarter, she 19 might not realize the company that lost two billion actually had 20 the better quarter because the company that had the gain had a 21 two-notch credit downgrade and the value of the derivatives went 22 down, the liability derivatives went down. And that created a 23 gain. The company that actually lost money did so because there 24 was a 50 basis point shift in the yield curve and, you know - I 25 mean, if I've created something that is so counter-intuitive, 0217 1 that somebody can't just make some logical sense out of what 2 they see, then it's a failure of the system, in my opinion. 3 That doesn't necessarily mean we have to create a 4 set of financial statements that somebody can pick up and read 5 Sunday afternoon when they want to, you know, just do some 6 casual reading. 7 So I think there needs to be a balance there. But, 8 again, I would really stress that the counter-intuitiveness that 9 can occur from the poorly constructed set of financial 10 statements presents a significant risk for customers. And as a 11 company that deals with policy holders, can be a threat to a 12 business in the event that we show losses that are non-economic. 13 MS. GANTNIER: I think your point was discussed in 14 the earlier panels, which is why people have resorted to using 15 cash flow information. Because net income isn't necessarily net 16 income. And it isn't necessarily about whether they've 17 performed well or not. 18 And so with the financial themselves don't give you 19 the information, you go to resort to a cash flow analysis. I 20 mean, it's telling us that there's something potentially wrong 21 with the accounting; potentially. 22 MR. STARR: We were scheduled to end in about twenty 23 minutes. So what I'd like to do now is just go back, do the 24 same thing we did in the last panel and that's go back to the 25 beginning. 0218 1 We set out to look at this issue because we thought 2 it was putting pressure on the system. We thought that 3 increasing the amount of measurement uncertainty and the basis 4 for measuring certain assets and liabilities was posing 5 challenges to prepares, to auditors and was difficult for 6 investors to understand. 7 There's been a lot of discussion in all three 8 panels, actually, about the importance of the business model in 9 driving how we measure assets and liabilities. 10 So at the beginning was measure uncertainty, how 11 much do we recognize and how best to communicate it. So what 12 I'd like is your final thoughts on that. 13 How much should we recognize and how best to 14 communicate it. So, the floor's open to whoever wants to start 15 off first. 16 MS. GROSS: Well, I'll start. I think we heard, you 17 know, among all three panels actually a lot of agreement on a 18 variety of points. A lot of understanding that accounting is 19 uncertain. I mean, some of this is an art, not a science. A 20 lot of it is an art, not a science. And that there is really 21 recognition by preparers and auditors and investors of that 22 uncertainty. 23 And, you know, where we need to focus is on helping 24 them understand how management views the business back to sort 25 of the business model, the operating model, what's relevant to 0219 1 that particular business environment and how we can direct their 2 attention there. And help eliminate some of the noise, whether 3 it's in, you know, MDNA or footnotes that's just sort of the 4 disclosure overload and focus on the things that are most 5 relevant to the most significant estimates, the most significant 6 judgements, the things that might have a material impact on that 7 business. How we can provide some more robustness in the 8 disclosures. Maybe there's a role for auditors through emphasis 9 paragraphs or association with critical accounting estimates to 10 help direct that attention. 11 But that's where I heard the investors talking about 12 what they'd like to see. 13 There was a lot of concern expressed about whether 14 we're going too far in terms of, you know, getting some of this 15 stuff onto the balance sheets. So I think that was - seemed to 16 be a widely held view that we need to sort of slow down that 17 process and focus on, you know, keeping the relevant matters in 18 the balance sheet, adding the disclosure about the uncertainty 19 in the footnotes and critical accounting estimates. 20 I actually was surprised that there was a lot of 21 agreement among panelists in all three of the sessions. 22 MR. STARR: I just want some clarification. You 23 said - I may have misunderstood you, but I thought you said 24 putting the relevant amounts on the balance sheets. Did you 25 mean "relevant" or "reliable," because some people when they 0220 1 hear "relevant" that really means trying to predict the future. 2 Because that's absolutely the most useful. 3 MS. GROSS: Yeah. No. I mean, you know, more 4 reliable in terms of sort of where we are now. I mean, there's 5 a lot of concern over whether we're introducing too much 6 volatility into the measures on the balance sheet. 7 MR. STARR: Right. 8 9 MS. GROSS: You know, there's a lot of imprecision 10 there. And are we introducing some things that are better 11 handled with disclosure about - about the uncertainty. 12 MR. STARR: Okay. Thank you. 13 CZARNECKI: I would add I'd like to get on board 14 with this as observations about really taking a serious look at 15 this financial statement reporting versus analysis idea. I 16 think she's got a really good idea there that may be completely 17 out of the box for the SEC and for FASB and PCAOB as well, but 18 there is a need for that kind of analytical capability. That as 19 long as it doesn't compromise the company's ability to be able 20 to manage its business on a confidential basis, there is a need 21 for that kind of analysis. It's done inside the companies 22 today. If they're running their business, they're doing it 23 already. 24 And to the extent that the investors have an 25 interest or a need in having that, I think the opportunity to be 0221 1 able to have literally bifurcated report that takes financial 2 reporting on one hand and analysis on the other and really 3 separates the two into two useful pieces of information, I think 4 that's a phenomenal idea. 5 MR. STARR: Yeah. I heard one other thing from Liz 6 and that is that we were combining financial reporting and 7 financial analysis and she really wanted to separate it. 8 MR. CZARNECKI: Yeah, that's what I want looked at. 9 MR. GALLGAGHER: Mike, if fundamentally, I mean the 10 financial statements should be reflecting the economics, right? 11 And the economics you can't do that without including a number 12 of measures. And I think Dorsey had it right, almost 13 everything. There's certain elements of uncertainty, so the 14 question, you know, where do you draw that line? 15 I think a good discussion that we had and I think it 16 was, you know, similar to the prior groups, is that, you know, I 17 think it's natural on the part of standard setters, auditors, 18 and regulators who spend all of their time in this to sometimes 19 take things to a level of accounting purity or technical purity 20 that doesn't reflect the economics. 21 And, again, I'll put myself in that boat as well. 22 If this is what you do all the time, you can always find 23 something that maybe is a little better and a little bit more 24 technically pure. I think the challenge is finding that sweet 25 spot. And I think that Bradley's point around business model, 0222 1 you know, how would management, you know, what is their business 2 model, how do they operate the business and how do they convey 3 that. I mean, ultimately as a good benchmark in terms of where 4 do you draw that line because it's a continuum. You can't say, 5 this is in, this is out. 6 From a principle standpoint, how do you ultimately 7 convey the economics and as a guidepost, what does management do 8 in connection with the audit committee and the auditors in terms 9 of, you know, how do they run that business. How does 10 management run that business. 11 MS. GANTNIER: Yeah, I would say that the question 12 about how to measure the uncertainty and then how to - we've 13 talked a lot about how to disclose it. We talked about how to 14 measure it. To me there's two pieces to it. 15 If measuring it produces something that doesn't 16 matter, i.e., it's not relevant because it's not part of the 17 business model, we shouldn't be measuring it. 18 And the second piece would be if when we do measure 19 it there's such a high level of uncertainty to it that the range 20 is greater than the materiality, we shouldn't be measuring it 21 because then, I think we're going to be rendering an opinion 22 about something that is not fairly presenting because it's 23 either not relevant or it's so unhoned, what was the point. And 24 that leads us back, then to disclosure. 25 So I think there's not one answer to it. I think 0223 1 there's sort of multiple answers depending upon the circumstance 2 and the type of uncertainty that we're talking about. 3 MS. PEGG: I would put myself in the camp that in 99 4 percent of the circumstances, measurement uncertainty should not 5 preclude a number from going into the financial statements. 6 Leaving that one percent for something that I haven't thought 7 of. 8 And with that, what I really think, as Jay had 9 introduced, what we really have to do is go back to re-thinking 10 the financial statements; the income statement and the balance 11 sheet. And putting those in a form that then can take the 12 financial reporting to the financial analysis where it provides 13 more information, say, through the financial statement 14 presentation project. That's - just a format that highlights 15 this information and makes it useful to investors. 16 MR. SPATARO: It looks like we're going around. 17 Yeah, I would make the observation in terms of 18 measurement uncertainty is that, you know, from an insurer's 19 perspective and also from an investor's perspective, I think 20 that there's naturally certain balance sheet items that have 21 uncertainty in their measurement. And I think that, you know, 22 P&C claim reserves. I mean, those already have, you know, 23 uncertainty in them. And what I would suggest is that they're 24 already measured and so that's fine. And that, you know, how we 25 deal with the uncertainty is I think that it's best dealt with 0224 1 through disclosure. I think that there are some ideas that are 2 out there that are being floated by the IASB in terms of, you 3 know, risk margins. I think that that's at least -- at this 4 point in terms of financial if we were to incorporate it into 5 financial reporting, I think that that's something that before 6 it could be done, there would need to be a lot of work done and 7 a lot of testing to determine whether or not it actually is, you 8 know, something that is credible information; that is useful to 9 investors. I think that, you know, to the extent that we 10 haven't even been able to fully test that, to field test that in 11 the U.S., that that's not a judgement that we could even 12 possibly render at this time. And I would think that even 13 before you could render it, you'd need several years under your 14 belt to look at, you know, how does it operate in different 15 business environments and different geographies, you know. You 16 know, under different business cycles. And that's just 17 information that we just don't have yet. 18 So I think that until we have that, I think that 19 there are mechanisms that exist today that we've talked about, 20 namely the critical accounting policies as well as the critical 21 accounting estimates. And then I think that we ought to focus 22 there and, you know, be certain that, you know, that we are 23 providing all of the relevant information about uncertainties 24 within those existing disclosures. 25 MR. HUNKLER: I think that you have to start with an 0225 1 analysis around what is the most relevant measurement basis. And 2 that needs to be the first variable. To me, that's where I get 3 back to the business model really should drive relevance. 4 You know, I've heard, you know, ISB staff and board 5 members say in the insurance contracts project that, you know, 6 we have to show asset liability duration mismatches in financial 7 statements for insurance companies. And I don't understand that 8 because it's not necessarily what investors are interested in 9 seeing. I mean, I think it's an interesting point and maybe 10 belongs in a disclosure. But it's not the most pertinent 11 measurement basis. So when you start with relevance and you 12 say, okay, now I've selected my basis and it's fair value or its 13 cost, then you should seek to define that measurement basis in a 14 way that minimizes the amount of uncertainties and how it's 15 calculated. 16 And that's where you kind of have to say, 17 uncertainty is the enemy of objectivity. Because you want 18 measurement bases and you want financial statements that have as 19 much objectivity and verifiability in them as possible. 20 And so I think it has to be a two-step analysis, 21 though, to produce meaningful financial statements. So with the 22 first step being relevance and the second step being, once you 23 selected your basis, then you'd look to minimize uncertainty in 24 it. 25 But we get sidetracked and we lose useability of 0226 1 financial statements and meaningfulness of financial statements 2 too often because we haven't selected the measurement basis that 3 is most pertinent to how the business is being managed. 4 And that could be using fair value measurement 5 basis, which may be more certain but more volatile and less 6 meaningful because it's not consistent with how the business is 7 managed. 8 So you start with the business management and the 9 relevance question and then you look to minimize uncertainties 10 as much as possible without necessarily damaging the value of 11 that basis. 12 MR. BASKIN: I think I would like to separate the 13 basis of measurement from the measurement uncertainty issue. 14 And so regardless of what you do - the poor insurance companies 15 on the basis of measurement, there will be uncertainty in the 16 measurement just as there is in other companies and other 17 measurements. 18 So to me the issue is what do we do with it? And, 19 Mike, I don't know for sure how to do it. I have my own 20 personal preference how it should be presented. But I think 21 getting it out of the back room in a private discussion between 22 management and the auditor, and into the financial statements, 23 has two benefits. One is it allows the comparability that 24 everybody wants because it allows those looking at this company 25 and another company to compare the uncertainty in the net worth 0227 1 and the earnings of those two companies. And it allows within 2 the financial statements the comparison of the uncertainty in 3 one line item with another. 4 And so getting it out in the public, so to speak , 5 in the financial statements, I think has that benefit of 6 providing users with very important information. 7 I think the other benefit for me as an auditor is 8 that that it should shift the burden from deciding whether the 9 uncertainty boundaries are close enough to - so the question is, 10 is the disclosure complete? 11 And it takes me out of the realm of being the judge 12 and jury on whether the measurement technique is adequate and 13 whether those uncertainty bounds are close enough to addressing 14 whether or not the information disclosed in the financial 15 statements is fairly presented. I would like to get to that 16 point. 17 So that would be my view is we need to get the 18 uncertainty described in the financial statements somehow so 19 that users have that information and so that I can focus my 20 auditing on the disclosure of that information rather than 21 trying to judge whether or not I can live with the uncertainty 22 around the point estimate that's all that's in the financial 23 statements now. 24 MR. SIEGEL: You know, it strikes me that one of the 25 things that - that - I'll start with what Mike said, Gallagher, 0228 1 that I totally agree with, which is that the accounting is 2 supposed to reflect the economics. And unfortunately the 3 uncertainty in the economic world is a lot greater today than it 4 was four or five years ago. Four years ago we knew auction rate 5 securities and CDOs were level one. Those were liquid. Those 6 were trading all the time. We knew what the values were whether 7 it's cost to fair value, we knew it. And now we don't. 8 In a world where the uncertainty in the economics 9 has increased, what's the accounting supposed to do? You would 10 imagine that the uncertainty in the accounting would increase as 11 well. Whether it's, again, a cost measurement with an overlay 12 in impairment to market level, you know, true of, or whether 13 it's fair value. 14 So what I get back to is, the dynamism of the 15 uncertainties from quarter to quarter from business model to 16 business model. I keep hearing about business models. The 17 quarterly supplements that insurance companies put out, just as 18 an example, since you two are at the table, 40 pages, you know, 19 et cetera. And some of that - so with an earnings release they 20 put out supplemental financial data, 40 what investors need to 21 know. Some of it is duplicative of what's in the accounting, a 22 lot of it's not, frankly. But those change every quarter to 23 some respect. 24 The headlines of the earnings release change every 25 quarter in some respect. So - and then we're trying to set 0229 1 accounting standards where measurement basis won't change. So 2 it's to your point, Brad. It's pick a measurement basis. Pick 3 a horse to ride and then you got to ride it, right? And then 4 even if uncertainties are going to ebb and flow around that as 5 the economic cycle does, you're going to have to deal with that. 6 So then it becomes a communication exercise. And 7 all three panels said you have to be more efficient and 8 effective in communicating the uncertainty in whatever the 9 management measurement basis is that we've decided to ride. 10 Whether it's in don't be duplicative. Whether it's in MDNA. 11 Whether it's in the supplemental, you know, we've got to figure 12 out a way amongst the three organizations. Whether it's in part 13 of the audit report that opines on MDNA. What were the most 14 important things that the auditors were thinking about as they 15 were analyzing those things, whether it's in the financial 16 statement disclosures or whether it's in MDNA. That's where I 17 feel like what I'm hearing is what we're going to really have to 18 focus in on as we - as we go forward. 19 But this has been extremely informative to me. And 20 I really appreciate the panelists views and insights and 21 especially the time given everything that's going on to take the 22 time and help us - help us through this. So thank you very 23 much. 24 MR. HANSON: Mike, I just want to make one comment. 25 And that's something that Liz and I were talking about before 0230 1 the panel started and she brought up that it is remarkable to me 2 how the investors and the auditors and prepares, I think from 3 today, I'm all hearing, we share the same frustrations, same 4 concerns and same goals to have better information with more 5 clarity and better disclosures so it's more meaningful to the 6 investors. So I think we've all come - I think all come to a 7 good understanding that we're kind of in the same plane and 8 we're trying to do the same thing it's just the challenge of 9 figuring out the path forward of how to best do it. 10 MR. STARR: Well put. Before I turn it over to Jim 11 to close, I want to thank you for just an outstanding session. 12 I think all three panels did a very good job. And I'll 13 reiterate what Jay said at the end. One of the things that's 14 really been interesting for me is the common themes that run 15 throughout from preparers, investors and auditors. So, again, 16 I thank you and I thank you for taking the time to be with us 17 today. 18 And I turn it over to Jim. 19 MR. KROEKER: Let me just echo Mike's thank you and 20 then also thank a number of people that were instrumental in 21 making sure that today's events actually occurred, not the least 22 of which is Mike Starr himself who was incredibly instrumental 23 in getting this vision to a reality. At the PCAOB, in addition 24 to those that were at the table, Chairman Doty and Jay, I'd also 25 want to thank Steve Richards and their chief auditor, Marty 0231 1 Bauman, who also were instrumental in reviewing materials and 2 preparing for today. 3 At the FASB, in addition to Marc and Leslie's 4 extreme dedication to this idea and continuing to push us to 5 say, how do we make this a reality. Also Sue Cosper who is here 6 with us. 7 And on our staff, in addition to Mike, Eric West, 8 who's somewhere also played - oh, right behind me - played a 9 huge role in facilitating today's events. So I wanted to thank 10 them. 11 One of the things we're looking for out of the 12 financial reporting series is actionable items. Of course, we 13 could have picked a narrower topic to think of ways to things 14 that were more immediately actionable but I did hear a number of 15 things. And I don't want to commit any of the three of us to 16 what the action might be. But I did hear things that are really 17 worth thinking about how do we execute on that. 18 Janet, you summarized well, but I think others said 19 the same thing in terms of disclosure; the importance of a 20 disclosure framework including, why do investors have to look 21 here, here, here and then the footnotes. I think that's an 22 actionable item that permeates all three organizations. 23 I also heard, holy cow, ideas like should we have 24 financial reports that are more historical in terms of their 25 report and an analysis or an analytical piece that is a separate 0232 1 report. I think that's something we have to think about that's 2 a fundamental shift to financial reporting. It's an actionable 3 thing but how do we go about it. And ideas all the way in 4 between. 5 And so one of the things that we're committed to is 6 as the three organizations is having follow up and then figure 7 out what do we take away from today's events. Not the least of 8 which might be a future financial reporting series that takes 9 what we heard today and tries to then summarize that and say, 10 are we hearing you correctly. If we head in a certain 11 direction, is that what is responsive to what we've heard. 12 The financial reporting series isn't only going to 13 be about measurement uncertainty so if you have good ideas for 14 topics where the financial reporting system can be improved, or 15 you see emerging risks that isn't being addressed by financial 16 reporting, I'd encourage you to call any one of the people I 17 said at the three organizations who were instrumental and/or 18 send an email to the financial reporting series mailbox that's 19 on our website and suggest in as little or as much detail as you 20 have, suggestions for future meetings. 21 With that, I think, unless I've missed something, 22 Mike. 23 MR. STARR: No. 24 MR. KROEKER: The First Financial Reporting Series 25 Roundtable is adjourned. 0233 1 (Whereupon, at 5:20, the meeting was 2 adjourned.) 3 * * * * * 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 0234 1 PROOFREADER'S CERTIFICATE 2 3 In the Matter of: INAUGURAL PUBLIC ROUNDTABLE FOR 4 FINANCIAL REPORTING SERIES 5 File Number: OS-4-640 6 Date: Tuesday, November 8, 2011 7 Location: Washington, D.C. 8 9 This is to certify that I, Susan Davis, 10 (the undersigned), do hereby swear and affirm that the 11 attached proceedings before the U.S. Securities and 12 Exchange Commission were held according to the record and 13 that this is the original, complete, true and accurate 14 transcript that has been compared to the reporting or 15 recording accomplished at the hearing. 16 17 _______________________ _______________________ 18 (Proofreader's Name) (Date) 19 20 21 22 23 24 25 0235 1 REPORTER'S CERTIFICATE 2 3 I, Susan Jellen, reporter, hereby certify that the 4 foregoing transcript of 233 pages is a complete, true and 5 accurate transcript of the testimony indicated, held on 6 November 8, 2011, at Washington, D.C. in the matter of: 7 INAUGURAL ROUNDTABLE FOR FINANCIAL REPORTING SERIES. 8 9 10 11 I further certify that this proceeding was recorded by 12 me, and that the foregoing transcript has been prepared 13 under my direction. 14 15 Date:____________________________ 16 Official Reporter:________________________________ 17 Diversified Reporting Services, Inc. 18 19 20 21 22 23 24 25 0236 1 2 Diversified Reporting Services, Inc. 3 1101 Sixteenth Street, N.W. 4 2nd Floor 5 Washington, D.C. 20036 6 7 8 In the Matter of: INAUGURAL PUBLIC ROUNDTABLE FOR 9 FINANCIAL REPORTING SERIES 10 File Number: OS-4-640 11 Date: Tuesday, November 8, 2011 12 Location: Washington, D.C. 13 14 This is a letter to inform you that we do not 15 release our tapes and notes. I do maintain 16 them for a period of one (1) year. 17 18 Sincerely, 19 _________________________ 20 Susan Jellen 21 22 23 24 25