Martin F. Baumann's Speech to the 9th Marcus Evans CFO Summit on November 7, 2004

Prepared Remarks by Martin F. Baumann
Chief Financial Officer, Freddie Mac

9th Marcus Evans CFO Summit
Scottsdale, Arizona
November 7, 2004

Thank you. I’m pleased to join you today.

I’m sure everyone here is familiar with the Conference Board’s “leading” and “lagging” economic indicators of the business cycle. For example, one leading indicator is building permits, while one lagging indicator is the average duration of unemployment.

Since I began my career as an accountant, I’ve been through five business cycles, and so I feel qualified to offer another lagging indicator to the list: namely, complaining and hand-wringing. A few months into every economic downturn, the complaining and hand-wringing builds to a crescendo – generally not diminishing until long after the economy has begun to expand.

Despite the immense potential for such behavior offered by my subject today, “The Changing Role of the CFO in a Post Sarbanes-Oxley World,” I’m going try to avoid such hand-wringing.

Instead, I’ll take a quick look at the path I believe Freddie Mac took to get to today’s post-Sarbanes-Oxley world. I’ll touch on some of the law’s demands. And then I’ll offer some practical suggestions as to how we all can best meet not only the letter, but the spirit of the law – and use it to improve our respective companies’ performance – based on my three decades as an accountant, and my eighteen months as CFO of a company striving to implement Sarbanes-Oxley and dealing with challenges of our own.

My message in a nutshell is that the time for complaining has passed. Sarbanes-Oxley is the law – we need to get over it and get on with it. Most of all, we need to make it work.

I began my career in finance, as an accountant at Price Waterhouse, in 1969. Although it has been argued that without double-entry bookkeeping, the industrial revolution, global trade, and today’s undreamed-of affluence would have been impossible, accountancy has not claimed its rightful place as a glamorous profession.

But back then, the position of CFO was not seen as especially exciting, either. The CFOs I met seemed a lot like the accountants I was working with -- they were known mainly for their precision and down to the penny record keeping.

And they had very simple accounting rules to follow. For example, between 1959 and 1973 (14 years), the Accounting Principles Board issued about 30 standards, which consisted of 350 pages. By contrast, the Emerging Issues Task Force and the Financial Accounting Standards Board issued more than 20 standards in 2003 alone –covering more than 300 pages.

But by the 1990s, the CFO’s life became more complicated. New and more complex financial instruments increased the opportunity to be “creative.” In unprecedented numbers, companies began merging, making acquisitions, handing out stock options, entering new markets, dealing with a proliferation of new products, and answering to shareholders looking for mega-returns. Companies focused unduly on short-term performance, and Wall Street guidance often became a marketing tool designed not to improve the bottom line, but to push stock prices higher.

Neither the increasingly antiquated reporting procedures nor the tried-and-true values on which companies had relied kept pace with these changes in finance and attitude. And then came the real go go days of the Tech and Internet boom.

At around the time the NASDAQ surged past 3000 – on the way up – it became clear that the title of CFO had accrued substantially more glamour than that of CPA. CFOs had become wizards with earnings magic, high-profile players who could dazzle Wall Street. They had become sophisticated financial engineers who, critics now say, were far less interested in doing the low-profile labor of providing accurate, complete and transparent reporting.

We all know what happened next. At about the time the NASDAQ surged past 3000 – this time on the way down – people were remembering that running a business is more important than running the numbers. At the same time, Congress was looking for a response to the high-profile greed that gutted some of the era’s highest-flying companies, and brought all of corporate America under public suspicion.

The result? When I moved from accounting to the high-profile role of corporate CFO, I found myself confronted by Sarbanes-Oxley and a lot of other unique challenges. And I realized that the only rational way to respond was, in many respects, to keep acting like an accountant.

Fortunately for me, I work for a CEO and a company that understands this. Our Chairman and CEO, Dick Syron, has set out to rebuild public confidence in Freddie Mac. He has set a new tone of candor and integrity from the very top level of the company on down. And he has empowered me as CFO to meet head-on the demands of the post Sarbanes-Oxley world.

As a result, I have the authority not only to “fix” our accounting systems and expertise, but to raise them to a new level of transparency and precision that will build public trust and become a model of corporate governance.

Just as important, I’ve been empowered not to take on roles and functions that can pose conflicts for CFOs and, at a minimum, distract their attention.

And that’s as it should be.

In the world shaped by Sarbanes-Oxley, the CFO should be transformed from an architect of earnings to a guardian of accountability, leading the way back to integrity and accurate financial results. As new reporting standards and internal controls are put in place, the CFO becomes an unimpeachable bridge to regulators, investors and other key constituents -- ensuring strict adherence to GAAP, to the highest ethical standards and to sound internal controls.

This return to traditional standards and behavior is backed by the mandate for public reporting on our internal controls, and for disclosure practices that some find uncomfortable. The audit committee too has a new and expanded role, and you and I – and our CEOs – now have to sign on the dotted line, certifying the accuracy and thoroughness of our financial reporting and reliability of those internal controls.

Sarbanes-Oxley is an attempt to legislate both process and ethics. As with any effort to legislate ethics and impose process, people are tempted to build to minimum standards, and ignore the larger goals of the law. SEC Commissioner Cynthia Glassman worried publicly last month that internal control and audit requirements would become a "check the box exercise with boilerplate disclosure,” rather than a tool for management, audit committees and boards “to monitor risks to and in the organization.”

My years in accounting and my work at Freddie Mac convince me that Commissioner Glassman is right. We have to go beyond minimum compliance and make the law work for us. Here’s why.

First, a great deal of credibility has been lost in corporate America by our failure to reconcile traditional business ethics with the new economic era. Investors, board members and regulators who still feel burned by the 1990s will not trust us until we reclaim our position as impartial reporters of the economic facts. We have to regain their trust.

If we cannot, resources better spent making our companies profitable will be spent answering questions about our methods and safeguards, and responding to regulatory pressures and media inquiries. Employees will be pulled away from productive work. And investors will continue to be wary.

And, second, we’re spending a lot of money already to meet the minimum Sarbanes-Oxley standards. So we might as well make the marginal investments needed to really get the value out of these changes.

Accounting Today Magazine quoted one CFO saying, “I’m doing it like I did before. I’ve added hundreds of thousands of dollars to my operating expenses, and I’m not doing anything different.” In my view, that’s a wrong and shortsighted approach.

At Freddie Mac, our substantial investments in accounting remediation are intended to take us beyond just fixing the problems of the past.

Our aim is to automate our systems from top to bottom. We’re hiring the right people into critical positions of responsibility. And we’re channeling more energy and resources than ever into developing leading edge accounting and financial transparency.

We’re beginning to emerge from what has been a long, dark and expensive tunnel. And we can finally see the light up ahead.

Of course, the changes brought by Sarbanes-Oxley affect the whole company. But I especially need to be an internal leader for the team – embracing change, and insisting on a high standard for honest, dispassionate reporting.

Being this kind of CFO – an empowered CFO – I have the ability to apply what I have learned for three decades: The importance of strong accounting policy skills. The benefits of pure financial reporting. The need for and benefits of solid internal controls. And the credibility gained from straightforward earnings guidance.

First, when I talk of the need for a focus on accounting policy, I mean that a CFO should have all the information needed to make a decision. And it should be generated by an internal accounting policy group that can compete with the best outside accounting firms – though I understand this may not be feasible for smaller companies.

“Good enough” is not good enough in the post-Sarbanes-Oxley world. We need the best. That’s why I created a policy team that is comparable with the best of our outside resources at every level.

Second, Sarbanes-Oxley makes tremendous structural demands of companies, particularly in the reporting function. At Freddie, those demands are compounded by our ongoing work to catch up on our reporting timetable and to re-establish a reputation for transparency and credibility.

My reporting system has to be accurate and complete. It has to satisfy Sarbanes-Oxley, a consent decree by our regulator, Wall Street’s needs and – don’t forget – the needs of my business partners. And it has to do all that without soaking up so much money that it hobbles the revenue-generating portions of the company.

There are points in this process at which outside experts are absolutely critical. But on the whole, somebody else’s team is not going to be able to build a structure that will be as responsive and cost-effective as the team I am now taking the steps to create.

And finally, when my signature goes on the certification, my confidence in doing so stems directly from my faith in my team, the people I work with every day, who have Freddie Mac’s health and well-being as their top priority.

Frankly, we CFOs as a group have to get over any frustration with the transparency requirements Sarbanes-Oxley has imposed. As challenging as these requirements can be, they force us to look beyond the short term and the stock price, and give greater weight to long-term, well-controlled performance. That’s a good thing. We’ve all seen what happens when problems are passed over every quarter until they are suddenly too big to hide. One day, investors are surprised to find that the company they own isn’t performing as expected. And investors hate surprises.

With better controls and increased transparency, today’s CFO must also aim for purity. Not “purity” in some larger philosophical sense. I mean purity as in a near-obsession with financial reporting that is as uncluttered and as unconcerned as possible – that is clear, unbiased financial reporting.

I know it sounds funny to non-CFOs, but we all know that there are a lot of ways to add the numbers up – we have to find a way to do it in an even-handed way without either a conservative or a liberal bent. If you try to influence the interpretation, it’s going to look in hindsight like you were managing the results – a definite problem in today’s post-Sarbanes-Oxley environment. The boardroom is going to have to learn to live with volatility in our financial statements, and so is Wall Street. Because that’s the way the real world works for most companies, most of the time.

Purity also speaks of a more focused role for the CFO. It’s hard to be pure in your results, to get the most out of your team and your new controls, and to meet transparency requirements if you are spread too thin and especially if you wear too many hats. Multiple roles can divert too much time and attention. And it can create contradictory demands that are almost impossible to meet. It’s like a hitter in baseball calling his own balls and strikes: there’s no way to do it without the risk or appearance of bias.

Therefore, be careful about putting business decision-making activities into the CFO’s office.

As CFO of Freddie Mac, for example, my job is to have a robust capital attribution model and use it to measure the effectiveness of capital deployment. It is not to make capital deployment decisions in the first place. That’s a good, clear division of labor that works for our company. It empowers me to be an unbiased, transparent and honest umpire.

Finally, I’d like to speak to earnings guidance. In giving guidance to your CEO, be as specific and as candid as possible – play the honest broker role. In giving guidance to Wall Street, don’t aim to tell the Street earnings to the penny. First, it can’t be done. And second, as soon as you do try to do it, almost by definition it influences the accounting outcome. Once you give a number, you’re going to have analysts on the quarterly call and all they’ll want to know is … did you hit your number, or miss it?

Instead, you need to talk about, and help analysts to properly weigh, long term trends and outlook, and how your company fits into larger competitive trends that will affect your business and thus your long-term returns. In short, concentrate on the drivers of your business – cost of goods, consumer spending, pricing trends and so on. Wall Street will have to live with less dumbed-down guidance and more intelligent information.

Although most of what I have said concerns the CFO’s relationship with executives, regulators, and investors, your relationship with your board of directors is critically important and, occasionally, very complicated. Boards, especially Audit Committees, are becoming more independent. Under Sarbanes-Oxley, they have to be and they should be. But, as with everybody else, the way to deal with them effectively is to remain firmly in the role of umpire.

Reporting with complete openness to the Board and maintaining a transparent process allows the Board and the Audit Committee, from their unique positions, to examine the company’s long-term health and performance and act responsibly on behalf of the shareholders.

In closing, Sarbanes-Oxley in many ways has made our lives as CFOs much more complicated. We have to create new accounting systems and controls within our companies, we have to answer to new regulators outside, and we have to make public information that in the old days might never have seen the light of day. And, of course, we face possible fines and even jail time if we don’t.

But I would argue that, properly approached, Sarbanes-Oxley can have a positive effect on the role of the CFO.

By creating a strong accounting policy team, we have the self-assurance that we will report complex transactions correctly. By thoroughly documenting and then testing our controls, we gain confidence that our systems and processes will produce reliable information. By approaching each financial reporting decision with an unbiased view, we greatly enhance our credibility with auditors, regulators, the Board and other key stakeholders. And by building a new risk-based capital management system, we appropriately set interest, credit and operational capital needs to each of our business functions. These are substantial efforts – but they are sound long-term investments.

Since I began my career, our nation’s gross domestic product has nearly tripled. Computers have become commonplace – and the Internet ubiquitous. The number of people with a stake in the stock market has mushroomed. Companies raise funds in ways undreamed of just a few years ago. And just as double-entry bookkeeping revolutionized an earlier era, the techniques and technologies of modern finance have helped bring all this about.

But the availability of new business tools does not make old values of integrity obsolete. Investors still need honest numbers. CEOs and board members still need impartial advice. Regulators still need straight information to protect the public good.

By being the person who provides all this – empowered by a CEO who understands that we have to make sound policy, pure thinking and transparent guidance the touch-stones for all we do – the CFO actually becomes more valuable, not less, in today’s environment. For corporate reputation is one asset that none of our companies can afford to squander. And at a government-sponsored enterprise such as Freddie Mac, the need to be a role model of corporate governance is particularly strong.

The new CFO is a surprisingly important role, and one that I am happy to play.

It offers all of us the opportunity not only to help our companies’ bottom lines, but in the larger sense, to help restore the credibility of corporate America.

That’s an honorable task, and worthy of every CFO in this audience.

Thank you. And now I would be happy to answer your questions.