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Financial Reporting: A Delicate Balance

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Barbara Stymiest
Chief Operating Officer
RBC Financial Group
CICA's Eighth Annual Financial Reporting and Accounting Conference
Toronto, Ontario

September 12, 2005

Thank you very much Steve [Steve Johnston, CICA Principal for Continuing Education] for your introduction and good morning everyone…….

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 system.

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 firms?
  • 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 of capital.

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 to Toronto.

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, "shortsighted."

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 will be].

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 our company.

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 net income.

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 issues.

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 others.

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 our partners.

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 person."

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 initiatives.

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.