(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

Fed Official Views Post-Enron Accounting Standards

The root causes of the recent breakdowns in corporate financial reporting are ineffective corporate governance, financial reporting, and risk management practices. This was the message delivered by Federal Reserve Board Governor Susan S. Bies to the Institute of International Bankers in New York City. Ms. Bies, who is a former member of the Financial Accounting Standards Boards's Emerging Issues Task Force, noted that the rapid pace of innovation makes it impractical to have a rule in place to anticipate every business transaction. Rather, she reasoned that accounting rules must be based on strong principles that are sufficiently robust to provide the framework for proper accounting of new types of transactions.

According to Gov. Bies, the core of these basic accounting principles should be professional standards guaranteeing that the accounting method selected faithfully represents the economics of the transaction. Similarly, disclosure must provide the user of financial reports with sufficient information to discern the nature of the significant transactions and risks of the organization. What is most needed, in her view, is a restoration of the integrity of corporate accountants and the quality of the audit process rather than extensive new accounting standards.

Many surprises that typically occur are due to the nature of risk exposures and the quality of risk management practices, including the use of off-balance sheet vehicles, said Ms. Bies, who was formally an executive vice-president for risk management at a large bank holding company. She recommends using internal controls and reporting systems to keep boards of directors and investors aware of these unseen risks.

In addition to applying sound accounting treatments, managers must ensure that public disclosures clearly identify all significant risk exposures and their effect on the firm's financial condition and performance, cash flow and earnings potential, and capital adequacy. Equally important, she continued, are disclosures about how risks are being managed and the underlying basis for values included in financial reports. She emphasized that a sound risk management system should continually monitor risks in a changing business climate, including credit, market, liquidity, and operational risks.

Disclosures consistent with the information used internally by risk managers could be very useful to market participants, she noted, as would information on the sensitivity to changes in underlying assumptions. She urged companies to do more than meet the letter of existing standards by ensuring that their financial reports focus on what is really essential to help investors understand their businesses and risk profiles.

Disclosure need not be in a standard accounting framework or exactly the same for all, she assured. Gov. Bies warned that disclosure rules built too rigidly in a climate of evolving risk management processes might be less effective in describing the risk profile of a specific organization.

Finally, she called on financial institutions to continue improving their risk management and reporting. When they are comfortable with the reliability and consistency of the information in these reports, she instructed, they should begin disclosing this information to the market, perhaps in summary form. This disclosure would have the dual benefit of providing more qualitative and quantitative information to the market, while at the same time provoking a discussion about risk management practices that would help the market assess the quality of the risk oversight and risk appetite of the organization.