After the Fall

The experts weigh in on how to prevent future Enrons.

Griep: From a rating-agency perspective, we make adjustments. We will reflect the rate to what we believe to be economic reality.

Willens: Well, isn’t the accounting supposed to capture the economic reality? Then you’re telling me that there’s some problem with the accounting principle.

Griep: But we would make adjustments. So wherever there is risk retained or some obligation retained…

Willens: But if there’s risk retained, it’s supposed to be consolidated.

Jenkins: No, not necessarily. To the extent that the transferor or sponsor continues to have exposure to risk, that is either supposed to be recognized on the financial statements or disclosed. For securitized assets in an SPE, SFAS 140 specifically requires disclosures about those assets.

I think one difference is — and this is an issue for financial reporting — S&P is supposed to be forward-looking. Financial statements are point-in-time. That’s at least one reason why you make adjustments. What we try to do, and what I think we’ll be doing more of, is put into footnotes information that helps on the forward-looking portion of the whole scheme.

Griep: We’re constantly making adjustments to the financials, but they have to be value oriented or adjusting cash flow in some way. We’re looking at the quality of earnings and adjusting cash flow or reported earnings based on what we believe to be the quality.

Willens: But doesn’t that bother you a little, that you have to make substantial adjustments from reported numbers?

Griep: No, I think it’s part of fundamental analysis, and I do think it’s a part of looking forward.

Defining Earnings

Willens: I guess I’m looking for something that maybe doesn’t exist. What I would like to see, and what a lot of people I speak to would like to see, would be one operating-earnings number that would have been created and blessed and certified by FASB. The components of it would be something that everyone would agree belonged in the computation of this ultimate number. I understand that that may be an impossible goal.

Jenkins: We are working right now on a project on financial performance reporting. Its purpose is to look at not only how the income statement is structured and the way it displays information, but also at certain cash flows and, to some extent, the balance sheet — to see if there’s a better way to display or aggregate or disaggregate the information, so that investors can have the opportunity to come to their own conclusions about what set of earnings is likely to be replicable in the future.

Willens: But people want to be guided here. I think they want more than just a framework.

Jenkins: We keep talking about how complex business is today, how complex the transactions are. I don’t think it’s possible to distill all that into one per-share number.


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