Select Committee on Treasury Minutes of Evidence


Examination of Witness (Questions 340-359)

PROFESSOR SIR DAVID TWEEDIE

TUESDAY 2 JULY 2002

  340. That is the extent of it?
  (Professor Sir David Tweedie) It is big; it is very, very big.

  341. Do you know the British equivalent figures?
  (Professor Sir David Tweedie) We are developing it. There was a group called the G4 of the major standard setters of the world. It was Australia, Canada, US and UK. Eventually New Zealand joined in but, as a former auditor, we did not think that made a material difference so we kept the G4 name. Basically what happened was that they proposed that these should all be charged and that was the British position too. We are now going through to produce an exposure draft. We hope to have one out at the end of this year and a standard next year. It will be hugely controversial, in America particularly. So there is a threat to the funding there.

Chairman

  342. Did your Board take any action as a result of the statements made to you in the US?
  (Professor Sir David Tweedie) At the meeting we made it quite clear that we would listen to arguments but we would not listen to threats and they could go jump in the lake if that was what they said. It has not changed us at all. Finding the money is not our problem.

Mr Ruffley

  343. You have given a very good example where there are radically different conflicting approaches to the treatment of some issues and the expensing of stock options is one such case. I think you are doing draft guidance on this in the autumn and you have also received criticism, not just from American companies but also the House of Representatives' Financial Services Committee. There is an example which is a radical difference of opinion. Could you give us, for the sake of argument, two other big issues of that magnitude where the Americans on the one side say of your draft proposals, "Forget it", something of the magnitude of the expensing of stock options? Will those be resolved?
  (Professor Sir David Tweedie) I suppose the one they are very worried about is pension cost accounting. They have a method which they have had in now for over 16 years. The difference between that and FRS 17 is that FRS 17 shows up starkly what has happened. The number is volatile, which is why it does not go through earnings and that is why it is stuck at the bottom of the balance sheet. If, for example, you had a deficit, the Americans would knock 10 per cent of whatever is the highest, the assets or the liabilities, off that figure and then they would spread that number over the working lives of the employees, so instead of a deficit of ten million you would end up with a number like half a million. I do not think you could explain that to your grandmother. You may as well take the ten million and divide it by the cube root of the number of miles to the moon and multiply it by your shoe size. It does not mean a thing. That is the issue which we really believe in. Accounting has to be absolutely transparent. One of the things we see in these markets today is that when there are doubts about what is going on the markets get very jittery. The reason we are in existence was the Asian crisis where companies which looked all right suddenly just collapsed. Funds would not go in because people were scared that the numbers did not mean anything, so growth stopped, unemployment rose, companies could get no cash for investment. The only way they could fix the economy was to clean up their accounting standards which is the issue we are talking about now. They then had a choice. They either went for American standards or international and that in a way is where we came into the picture. The Americans proposed that. They proposed that the international standards should not be American standards. They were quite decent in that respect.

  344. So we have expensing of stock options and the pensions point. Would you care to quantify how many other big sticking points there are as between the US authorities and companies and you?
  (Professor Sir David Tweedie) Another one, and the Americans might even agree with this, could be lease accounting. There are billions of pounds off balance sheets in leases. It is a very simple thing. Generally speaking when you lease something you just charge the rental per annum. In fact you have committed yourself to probably seven years' payments, something like that, so why have you not shown the liability. That is going to transform balance sheets. These are big issues: pensions, share options going through the income statements, leasing and these special purpose vehicles. We are looking at what the Americans have done and we are having a meeting at the end of this month which Mary is attending too with the Americans and Germans to see what we are going to do about these special purpose vehicles and whether we can come out with an international answer. Let us try to break it. One of the things we have to do is game it so we can consider what we would do if we were on the other side trying to play games with this standard and how we can fix it.

  345. Those are very helpful answers on the specifics. Could you tell us what the likelihood is of making international standards mandatory from 2005 as the EU have decided should be the policy?
  (Professor Sir David Tweedie) Mandatory when?

  346. International standards from 2005.
  (Professor Sir David Tweedie) We know certain countries are going to follow us. There is one major Commonwealth country, which I cannot mention because it is coming out shortly, which is also going to go for 2005. Our job is to make sure that Europe and these countries have the standards in place by then and quite frankly our programme is all 2005 predicated. What are we going to get done by 2005? One of the big issues we have is that European companies cannot go straight onto the New York Stock Exchange without reconciling to American standards. The SEC have issued what they call a concepts release which asks the question: do you think international standards are good enough? Should we allow them? They did that about two years ago. The answers were mixed. The Americans said certainly not, they are not good enough. The non-Americans said they were fine. That gave the SEC a political problem. I do not blame them for not accepting them because I voted against several of them in my time. What we have done is to pick up a lot of their criticisms and tried to fix them quickly. That is a project we published a couple of months back. What we are now doing is meeting with the SEC and the American standard setter and looking at the major differences, who has the best answer. In certain cases it will be neither of us, in which case we look for another standard setter and that is the intention. We are going to go through these differences as fast as we can with the intention of having the main ones out of the way by 2005.

  347. Do you think that target will be a hit across the year?
  (Professor Sir David Tweedie) Certainly if the EU are taking our standards they will have to take them whatever we do. The intention is to have one big change and not a series of changes. We have a priority programme to pull these two together as quickly as we can.

Mr Mudie

  348. Can we go back to stock options? Which country in particular or countries in particular are objecting to the proposal and threatening to stop your funding?
  (Professor Sir David Tweedie) The United States.

  349. Just the United States?
  (Professor Sir David Tweedie) Mainly the United States.

  350. You say "mainly".
  (Professor Sir David Tweedie) It is so prevalent there, that is the difference.

  351. Sorry, but you said "The United States" and then when I said "Just the United States?" you said "Mainly the United States". That suggests other countries as well.
  (Professor Sir David Tweedie) Not to the same extent in the sense that when—

  352. No; to any extent.

   (Professor Sir David Tweedie) People did not like it.

  353. Which "people"?
  (Professor Sir David Tweedie) Industry mainly. When you put out these proposals—

  354. Sir David, may I just stop you. We have the United States clearly listed as not liking this. Which other countries or representatives from other countries did not like it?
  (Professor Sir David Tweedie) I would not list other countries. All I would say was that when it was exposed, certain people answered saying they did not like it. That is quite different from the lobbying which goes on in the United States. I have not had letters from any MPs about it saying that I must stop doing this, yet. We have had letters like that from Senators and Congressmen.

  355. How much does your organisation cost?
  (Professor Sir David Tweedie) It costs about $11 million a year—£7 million. Most of that is my salary!

  Mr Mudie: You will know how to deal with it if it does not come in.

Mr Ruffley

  356. The reason why American business is so upset about the expensing of stock options is because it will hit profits. What I do not quite understand is why EU companies and companies in this country are not equally concerned about what will happen to their balance sheets if this expensing of stock options is introduced. Why should the Americans be so much more concerned than British business or business in France and Germany, because it is going to have the same effect? Is it because we are just a bit dopey in this country?
  (Professor Sir David Tweedie) No, it is not on the same scale; that is the big difference. We estimate, for example that for every employee of Yahoo the amount of share options in the year 2000 was $400,000. That is a lot of money and that is part of the problem. If we go around knocking the profits down, the share price is going to come down and these options are going to go under water. The whole question of aggressive earnings management is one of the big problems we are facing. If you can hold the share price for three or four years so you will be so rich that your family will be taken care of for generations to come, you can see what the temptations are going to be of just ramping the profit figures. That is why we are absolutely convinced that the way to deal with this sort of situation is to be pretty brutal, not listen to compromises, if it is a liability it is on balance sheets, the leasing should be on, pensions should be on, share options should be charged, if you control a special purpose entity you should consolidate it. Let us forget the exceptions, that is it. We will hear special pleading, "We're different" but you soon learn that the world is a special case after a while in this job. That is one of the things we must not listen to because the way to clear up the crisis is the way we had to deal with it in the early 1990s in the UK, just to be bloody-minded and do what we think is right regardless of what people say. I shall listen to Congressmen writing in if they have a good accounting argument, but if they just do not like the answer then I am not listening at all.

  357. The reason there is a difference is because the use of share options is much more widespread, the quantum is greater in the States and less significant here relatively speaking.
  (Professor Sir David Tweedie) Yes. That is a good reason for bringing it in here before it does become significant.

Mr Laws

  358. This issue of stock options. In what proportion of the leading US companies would this be a material factor in their accounts if it was accounted for in the way that you desire?
  (Professor Sir David Tweedie) Probably most of them. Some people say that it is costless and all they are doing is issuing shares. You are issuing value and that is the problem. You are giving away value when you could sell these options; it is company money which you are giving away. They say it does not cost at all and it is just a dilutive effect. In fact a survey done in the States a year or two back showed that about 300 companies in the top 500 were actually buying back shares to stop this dilution. On average they spent $479 million each. We are talking about huge numbers.

  359. Are you saying that in these top companies in the US if the information were more transparently given out, it might have some impact on their market valuation?
  (Professor Sir David Tweedie) Oh, yes; at present, yes.


 
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