Financial Reporting: A Delicate Balance
Chief Operating Officer
RBC Financial Group
CICA's Eighth Annual Financial Reporting and Accounting
September 12, 2005
Thank you very much Steve [Steve Johnston, CICA Principal
for Continuing Education] for your introduction and good
The headlines this morning and throughout the weekend continued
to be focused on the efforts to recover from the tragedy wrought
by Hurricane Katrina a couple of weeks ago. In thinking about
what's going on in the Southeastern U.S., I am also mindful
that yesterday was the fourth anniversary of the horrific
and tragic terrorist attacks on the United States. All of
this gives me pause to stand back to admire and celebrate
the resilience of the entire world's response to the enormous
destruction and devastation of 9/11.
Four years ago, human tragedy was matched by heroism; ruin
was countered by restoration; and our horror turned to resolve.
I was CEO of the TSX at the time, and in addition to being
mindful of many friends and colleagues who were affected by
the collapse of the Twin Towers, I recall being gripped by
enormous determination and purpose to ensure The Exchange
was available to carry out its important role in our economic
I was keenly aware that the integrity of infrastructure and
the availability of information were key drivers of confidence
in our economic system.
And then, only weeks after the Twin Towers fell, we were
again reminded that integrity can also be attacked from within,
when Enron imploded under the pressure of a crushing debt
load obscured by what can charitably be characterized as the
poor quality of publicly available information about the corporation.
As swiftly as Manhattan and Washington began rebuilding from
the terrorist attacks, regulators, policymakers and business
leaders also began work to repair the damage to the integrity
of our markets. There was a new order of the day for all market
participants: to rebuild confidence in financial markets.
We saw widesweeping legislation and changes to the management,
board of directors, regulation and scrutiny of public companies.
These measures have spawned countless studies, cottage industries
for commentators, and, of course, turned SOX from an item
of clothing that covers your toes to a blanket of new regulations.
I do not intend to provide a wide-ranging discourse this
morning about the events of the past four years, but rather
to talk to you about a cornerstone of market confidence: the
quality of financial reporting and disclosure. This morning,
I want to discuss how the marketplace views and interprets
financial information. And I want to address how these shifts
have made dramatic changes to the accounting profession -
in my view, for the better.
Several years ago, Dr. Robert Howell, the distinguished visiting
business professor at the Tuck School of Business at Dartmouth,
offered the following observation on this subject. He said:
"Financial statements, including the income statement,
balance sheet and statement of cash flows are almost as useful
as an 80-year old map of Los Angeles."
I'm sure there are many of us in this room who have agreed
with Dr. Howell at some point in our careers. My intent is
not to explore the historical reasons for how financial reporting
got to this point, but rather to look at how we might reverse
this perception. From my perspective, financial reporting
simply cannot be seen as an out-dated map: it must describe
for investors the steps taken by a company in the past and
its direction for the future.
[TO AUDIENCE] I'm just going to ask for a show of hands here:
- How many of you work for preparers of financial
information - either with public companies or public accounting
- How many of you are users of the financial statements
issued by the first group of people - perhaps you are analysts,
bankers or investment professionals?
- And, finally, how many of you are in oversight
roles, such as the OSC or other regulators?
The reason I'm asking these questions is to show that there
are at least three different categories of CAs who work with
financial information: preparers, users, and those in oversight.
Each of you has a different and critical role in the life-cycle
of financial reporting. As such, you each have different needs
and different objectives for financial reporting. Each of
you has a different agenda with regard to financial reporting.
And each of you is entitled to the right information to ensure
the proper functioning of our market.
The public company, or reporting issuer must consider the
needs of all stakeholders and provide excellent and understandable
disclosure that satisfies all of them.
In 1996, a study by Mark Lang and Russell Lundholm found
that, and I quote, "firms with more informative disclosure
policies have a larger analyst following, more accurate analyst
earnings forecasts, less dispersion among individual analyst
forecasts and less volatility in forecast revisions."
What management team can't see these as critical benefits?
Lang and Lundholm's study further suggested that the potential
benefits of sound disclosure can also reduce a firm's cost
A recent article in The Economist is even more eloquent on
the need for good disclosure: "Reliable numbers mean
that investors can make sound decisions. Bad ones lead not
just to insufficient allocation of capital, but also to a
loss of confidence in the markets, and when fraud is involved,
to huge shareholder losses. A study by Glass Lewis, a research
outfit, found that investors lost well over 900 billion dollars
in over 30 big scams between 1997 and 2004."
So if the prospects of poor investor interest, expensive
cost of capital, and large shareholder losses are not daunting
enough to convince a management group of the merits of good
disclosure, then let me appeal to simple self-interest.
It's the law. Pure and simple. Legislation and regulations
now exact harsh penalties for incompetent or dishonest disclosure.
Ask Bernie Ebbers. Ask Andrew Fastow.
To add to Dr. Howell's assessment of the usefulness of financial
statements, issuers must provide better directions in their
financial statements to investors. Without them, investors
will be lost. So how can we improve the quality of our directions
and provide better context and better discussion of trends
and other variables? And what constitutes proper directions
or sound disclosure?
In the cartography of financial reporting, the balance sheet,
the income statement, and statement of cash flow are indicators
that help users orient themselves in navigating the company's
financial disclosure. Like a mapmaker needs to mark True North,
companies must ensure their financial statements are technically
accurate in accordance with GAAP, so investors can head toward
the proper conclusion or destination.
GAAP is not perfect. It can't always provide a clear or complete
picture of corporate performance. Simple technical compliance
with GAAP without sufficient context can often provide only
a partial description of a company's performance. Unfortunately,
rules-based accounting standards have now become so precise
and complex that many professionals have tended to focus on
the lines drawn as opposed to the principles that created
them. The argument has been made repeatedly that GAAP stresses
sticking to the letter rather than the spirit of the law.
As the British commentator Michael Wilson puts it, "GAAP
virtually challenges the accounting community to think up
ever more ingenious ways to force its inconvenient figures
to fit it."
Clearly technical accuracy and compliance are not enough
to provide the complete picture of a company's performance.
The complexities of business have proven that innovations,
such as derivatives and off-balance sheet transactions have
critically important roles in our system. But using these
tools to conceal the true financial condition of a company
is not one of them. Rules-based accounting arguably demands
that companies fit performance into a framework, and this
sometimes leaves significant opportunity to conceal or omit
information because the standards cannot possibly keep up
with all financial developments.
I tend to agree with one SEC commissioner who said the more
specific the rules, the more temptation there is for companies
to create transactions to circumvent them, and avoid disclosure.
To paraphrase Commissioner Cynthia Glassman, the substance
of a transaction should dictate the accounting, not vice versa.
In late July, the Accounting Standards Board released its
draft strategic plan, saying "it is now widely accepted
that rules do not necessarily result in better financial reporting."
That said, principles-based accounting is not perfect either
- for example, it can make for difficult comparisons of companies.
The debate about rules-based versus principles-based standards
is significant and a topic for another time. I applaud the
standards setters for considering all the issues as they revise
and revisit existing standards and create new ones. But
their work is only one component of good reporting: GAAP is
the foundation for disclosure. It is the means, not the end
of good reporting.
In a speech entitled, "Restoring Investor Confidence:
The Key is Disclosure," the Undersecretary of the
U.S. Treasury Secretary at the time [Peter R. Fisher] said
that companies must observe "the longstanding principle
that GAAP compliance does not satisfy disclosure obligations."
Obviously there is another venue of financial reporting that
complements the technical accounting work. If technical accounting
provides a small and often incomplete snapshot of a company's
performance, the Management Discussion & Analysis paints
a broader picture, showing that good management is, at least
to some degree, an exercise in long-term planning.
Financial reporting, therefore, must also include some sense
of a company's strategic objectives as well. If we accept
that the balance sheet, the income statement, and statement
of cash flow comprise our map, then the SEC has made it clear
that the legend of the map of financial reporting is the MD&A.
Thinking of our financial statements as maps helps us understand
how much financial disclosure has changed over the past several
decades, let alone the last five years.
Looking back, Dr. Howell is arguably right; financial statements
of the past were actually not very useful maps of corporate
performance. By definition, they reflected corporate performance
at a point in time with little contextual information. The
MD&A provided a simple narrative of the financial tables.
I'm exaggerating slightly to make my point, but looking at
financial statements from 20 years ago would be like looking
at the map of a trip from Vancouver to Toronto, consisting
of one straight line with nothing other than the origin and
destination marked at either end.
As I said earlier, I see the MD&A as giving valuable
context and information to help readers understand where the
company has been and where it's going. A good map provides
more than just the names of the origin and destination; it
has information about landmarks, services and facilities along
a route. A good map would tell travelers that the trip from
Vancouver to Toronto crosses mountain ranges and rivers -
all on a paved highway that goes from two to eight lanes,
depending on where you are.
Similarly, the MD&A should explain the financials, not
parrot them. The MD&A should enable investors to fully
appreciate the risks, the potential and the reasons behind
past performance. The MD&A is also forward-looking and
therefore is an opportunity for management to describe its
motivation and rationale for future decisions.
More detailed MD&A disclosure - like the legend of our
map -- would even let the traveler know they can expect to
encounter strong prairie winds and the treacherous terrain
of the Canadian Shield. There may be discussion of the beauty
of the Great Lakes or the harshness of crossing Manitoba and
Saskatchewan in January. There might also be a description
of road construction in the interior of B.C., a new bridge
set to open in Alberta and increased traffic as you come close
You get the point. A good map provides you with not just
a snapshot of the route, but the conditions encountered and
expected during the journey as well. Good financial disclosure
should do the same: highlight the history, trends, strengths
weaknesses and the plans that management intends to pursue.
Let me return to GAAP for a second. As I said earlier, GAAP
is a very limited tool and can only partially explain a company's
story. Arguably, the MD&A is intended to provide investors,
shareholders - these are the owners of a company -
with management's knowledge of the company's operations. The
deliberate phrase "through the eyes of management"
is regularly used to describe the purpose of the section.
And while regulators have tended to scrutinize use of non-GAAP
measures and other business metrics, these can be important
to understanding material changes or items. These are the
elements of disclosure that would best help investors see
the company from management's perspective. If management relies
on certain non-GAAP measures and other business metrics to
manage the business properly, disclosing the most important
ones is vital to providing what analysts like to call 'colour'
to the financial statements.
As you know, the SEC requires reconciliation and explanation
of non-GAAP measures with their GAAP equivalent. While potentially
burdensome, this requirement for reconciliation does impose
a discipline to ensure non-GAAP indicators are used only when
necessary to enhance the quality of discussion.
Clearly, I am opposed to any attempt to make the MD&A
the place for boilerplate disclosure. Chris Hicks, the CICA's
principal for Knowledge Development, wrote in this month's
issue of CA Magazine about building a better MD&A. In
his piece, he is quite succinct on the value of MD&A.
Simply complying with regulatory requirements is, I quote,
The MD&A should be an honest and coherent discussion
of a company and its prospects. It should help answer the
question: "Why should I invest in this company?"
The best MD&As should be gripping and page-turning stories.
I have to again tip my cap to the CICA Canadian Performance
Reporting Board for their efforts to raise MD&A standards
by developing a set of principles and a framework to help
issuers create their MD&A. I'm sure most, if not all of
you, are familiar with National Instrument 51-102 [or soon
At RBC, we take compliance seriously and we want to
be sure we provide additional disclosure to users that may
help their understanding of our company. As an interlisted
company, we are subject to the numerous Canadian regulators
and their rules as well as SEC rules. In addition, we are
under the scrutiny of at least 15 sell side analysts and many
more buy side analysts and investment professionals covering
As you can guess, we spend considerable time discussing and
devising ways to improve our MD&A disclosure. Our overall
objective is nothing less than to ensure our external reporting
effectively and convincingly communicates our key messages
while meeting all key stakeholder requirements and expectations.
The MD&A is our story and we want to make it clear
so that the reader can see what's most important to our operations
and performance. Our principles for reporting include making
the MD&A easy to read and understandable, focusing on
key trends, drivers, events or other noteworthy changes. As
the CICA and other guidelines prescribe, we strive to use
plain language in our commentary, being thoughtful and focused
to explain why a change has occurred, rather than the structure
or composition of the change.
We use a top-down approach to explain our results and highlight
the areas of strategic focus. We are taking the time to focus
on material items or changes while also discussing economic
and competitive influences on our results. This includes giving
investors our outlook on business trends and their potential
impact, though it should be noted we do not give guidance
on key financial indicators, such as earnings per share, or
Those who have read our MD&A will also note that, in
the interest of providing a balanced story, we have not
avoided discussing our weaknesses or initiatives to resolve
For us, improving our MD&A is a continuous process as
we digest changes to accounting standards, regulatory demands
and best practices in light of any organizational changes
we undergo. That said, our framework is clearly predicated
on offering investors a strategic discussion of our operations
to complement our technical disclosures.
Many other companies are thankfully using a similar approach
of balancing strategic and technical objectives in their disclosure.
CAs have an exciting opportunity to respond to the transforming
needs of the business world. Scandal and resulting regulatory
changes have heightened demand for integrity and accountability
of financial data: the traditional and most essential role
of accountants and auditors. But CAs must now stretch their
skills and widen their focus so they can better advise business
leaders on how they can achieve their goals.
Traditionally, in companies around the world, CAs now have
responsibilities that are either Supplier or Governance oriented.
In Supplier roles, CAs tend to fill roles of being internal
suppliers of services to revenue producing operations. Governance
or Compliance-oriented roles are designed to ensure enterprise
wide standards are met to ensure, among other things, that
laws and regulations are followed and opportunities for efficiencies
can be gained.
CAs are professionals who have indispensable technical expertise
- you are vital to the success and efficiency of your companies.
Every day, you demonstrate professionalism, responsiveness
and trust in everything you do.
It's a great foundation to build upon.
Today as increasingly complex businesses seek to expand their
reach and scope, we, too, as professionals must expand and
broaden our roles beyond being technical experts. In the words
of Jim Carroll, the FCA who is also a business commentator,
we would do well to remember that we have a critical role
- I'm quoting here - "to provide organizations with
the insight and agility needed to survive and thrive."
That's the essence of why we're here - financial management.
As a business leader and a CA in a complex multinational financial
services firm, I understand the increased demand for financial
management expertise and I am heartened to know that the CAs
with these skills are evolving in my organization and many
We are taking on the roles of strategic planning, mergers
and acquisitions, risk, branding, communications, and law.
As Chief Operating Officer of RBC, I am responsible for all
of these areas.
Over the past several years, finance departments have shifted
their roles to enhance the value they provide to their organizations.
CAs cannot fulfill their financial management duties by simply
"counting the beans." CAs must become multilingual.
CAs need to be conversant in matters beyond technical accounting
issues so they can provide sound advice to their organization
in everything from financial management to structuring transactions.
As financial professionals in the 21st century, we must be
intelligent and insightful advisors to our clients and/or
At RBC, our financial professionals are encouraged to take
on roles outside of our head office environment. Today, there
are many financial professionals working in all of our businesses
so they can expand their knowledge base while giving the business
the benefit of their acumen.
The specialized recruitment and consulting firm Robert Half
International [the sponsor of today's lunch] says there is
a growing demand for accountants capable of financial analysis,
internal audit, forensic accounting and enterprise risk management.
Dennis Beresford, the former FASB chairman, sums it up by
saying, "The non-specialist specialist - that is someone
who is enough of a generalist and smart enough to work in
a lot of different areas - is going to be a very valuable
Today, compared with a few years ago, you are more often
involved, consulted and sought out for key business decisions.
Why? Because your skill sets can provide valuable insight
to business leaders looking to assess the viability of their
CAs must continue to demonstrate sound financial stewardship
to stakeholders, be active business leaders, providing value
through planning, analysis and performance measurement.
Circumstances have provided CAs with an opportunity to challenge
the status quo - we can prove we are capable of going beyond
what has been traditionally expected of our roles.
In addition to creating a more efficient organization, you
can be even more satisfied in your choice of career.
I hope for many of you, you will find this direction to be
refreshing, exciting and challenging. For some of you, I recognize
this new direction may also be intimidating and different.
But that's good. Thinking differently is a challenge with
a great deal of promise.
So wherever you are - whether in a public company, a public
accounting firm or a regulator - lead your teams and your
departments to become agile, responsive and proactive centres
of expertise that, as true partners, help your organizations
accomplish their objectives.
As I began in my remarks, stakeholders demand financial disclosure
to be technically compliant while explaining strategic objectives
and direction. Shouldn't they expect their accounting professionals
to be the same?
Thank you for inviting me this morning. I'll be happy to
take any questions.