As a result of the recently recognized failures of accounting disclosure, the market was unable to appropriately discipline the risk-taking activities of these firms on a timely basis because outsiders lacked the information from financial statements or other disclosures to do so. As critical information became available after the fact, the market reflected its concerns about underlying business practices and accounting through the declining values of equity and debt.

But, according to Governor Bies, improvements in accounting and auditing standards are also needed. In particular, fundamental principles and standards should be revised to emphasize that financial statements should clearly and faithfully represent the economic substance of business transactions. There is also a need to move toward principles-based accounting standards rather than continue to rely on rules-based accounting standards, since accounting rules tend to lag behind market innovation. Standards should ensure that companies give appropriate consideration to the substantive risks and rewards of ownership of their underlying assets in identifying whether risk exposures should be reflected in consolidated financial statements.

Besides applying sound accounting treatments, she continued, company managers must ensure that public disclosures clearly identify all significant risk exposures, whether on or off the balance sheet, and their impact on the firm's financial condition and performance, cash flow, and earnings potential. With regard to securitizations, derivatives, and other innovative risk-transfer instruments, traditional accounting disclosures of a company's balance sheet at a point in time may not be sufficient to convey the full impact of a company's financial prospects. Equally important are disclosures about how risks are being managed and the underlying basis for values and other estimates that are included in financial reports.

Unlike typical accounting reports, information generated by risk management tends to be oriented less to a point in time and more to a description of the risks. She urged complex organizations to improve their risk-management and reporting functions. When they are comfortable with the reliability and consistency of the information in these reports, they should begin disclosing this information to the market, perhaps in summary form. Such disclosure would provide more qualitative and quantitative information about the firm's current risk exposure to the market, as well as helping the market assess the quality of the risk oversight and risk appetite of the organization.

Further, a sound risk-management system in a complex organization should continually monitor all relevant risks, including credit, market, liquidity, operational and reputation risks. Reputation risk, which recent events have shown can make or break a company, becomes especially hard to manage when off-balance-sheet activities conducted in a separate legal entity can affect the parent firm's reputation. For all these risks, disclosures consistent with the information used internally by risk managers could be beneficial to market participants.

In this regard, she said that the Financial Accounting Standards Board missed an opportunity in their recent exposure draft proposing changes to the accounting treatment of special-purpose entities. The exposure draft focused on whether to consolidate an SPE, but said little about disclosure. If FASB's goal is to make the financial reporting of firms' dealings with SPEs more informative, she reasoned, disclosure of the effect of the SPE on the firm would be equally necessary. For example, if firms securitize receivables through commercial paper conduits, those receivables are no longer on the company's books under current accounting standards. Yet the aging of receivables is a key indicator that investors and lenders use to assess the quality of sales and operations. If the receivables move off the balance sheet, information about the aging of the receivables should continue to be part of the firm's disclosures. Further, the disclosures should include the firm's internal assessment of how its dealings with the SPE alter its risk exposures.

Finally, Governor Bies noted that disclosure need not be in a standard accounting framework, nor exactly the same for all organizations. Rather, each entity should disclose the information its stakeholders need to evaluate its risk profile. Companies should be less concerned about the vehicle of disclosure and more concerned with the substance of what information is made available to the public. On this theme, she cautioned that disclosure without context may not be meaningful.