That is the senior partner and chairman emeritus of one of the most prestigious accounting firms in the world. Everybody knows the odds on a roulette wheel.

  Translated even further, it means that if you see Universal Widget reporting $1 of earnings, that $1 can be 50¢ or $1.50, depending on which way they are playing the guitar that week. Where does all this flexibility come from?

  Well, you could change your depreciation from accelerated to straight line. If your depreciation charges are higher, then your profits are lower, so to increase profits, decrease depreciation. A couple of years ago Armco Steel did just that. Its president, William Verity, said, “The move was a defensive ploy designed to get the stock up and out of the reach of asset-hungry conglomerates and other acquisition-minded folk.” Of course, some future year your furnaces may be falling apart, and you without a cash reserve for new furnaces, but in the long run we are all dead—let’s get the stock up now.

  You can change the valuation of your inventories. You can adjust the charges made for your pension fund. You can make a provision for taxes on the earnings of a subsidiary or wait until the subsidiary remits a dividend to the parent. You can capitalize research instead of expensing it. You need not go as far as the gentlemen at the United California Bank in Basel to avoid showing losses; there are legal means at hand. You can defer the costs of a new project until that project brings in revenues; if the project never comes off, you will take a bath some future year. There are, in addition, other “discretionary expenses.”

  There is a phrase for this philosophy. It is called Après moi, le déluge, or as Scarlett O’Hara said, “I’ll worry about it tomorrow.” If you do manage to get your stock up, you can go out and buy another company which has some assets and some earnings but whose stock has not gone up. Then you can play with pooling and purchase, although not as much recently as in the good old days. With the newly purchased company tucked in, you can keep the game going.

  All of the devices described are generally done with an eye on the stock, not on what might be considered economic reality. The stock market cares about current earnings; they took our old, quiet System and ran it right into the ground. “No one objects to a ruling,” said James Needham when he was an SEC commissioner, “as long as it improves the earnings. If you touch the X-ray the other way, they scream.”

  Conversely, if you have a bad year, if the write-offs begin to catch up with you, if your stock is down anyway, then you gather up all the sins you can find and lump them all into the bad year. This is called “take-a-bath accounting,” even by the accountants. The idea is that as long as your stock is down, you might as well get all the bad news for several years in each direction out of the way, cancel the old option plan, vote new ones, and hope the stock will go up again next year.

  Two notes before we take off on the accountants. The first is that it is business itself that wants to write the books this way. Accountants may sign the statements as independent professionals, but they want the accounts; that is how they make their living. So if you are an accountant and you choose not to go along with reporting all the income but deferring all the cost, the businessman is likely to say, “Get lost; I’ll get myself another accountant. A more cooperative one, who understands me.” This is called “shopping for accounting principles.”

  The second note is that once again, there are some honest men and some honest businesses. James Needham, who is an accountant as well as a former SEC commissioner, and who is now president of the New York Stock Exchange, said there were less than fifty serious errors in nine thousand statements filed with the SEC. Only twenty-two out of Fortune’s top 100 companies, said he, showed discrepancies between what they reported to the public and what they reported to the SEC.

  (Yes, there are differences. Companies report on 8K and 10K forms to the SEC, and on the grounds that the SEC needs more information than the public the information may be not only more extensive, but different. The 8K form now requires that companies also report whether any change in the auditor has taken place and whether that change involved a disagreement in accounting principles. The auditor who has been canned is supposed to say whether he agrees with the reason for seeking another auditor. That leaves the public with only two problems. One, disputes are not likely to be carried as far as the SEC, and two, the security analyst—much less the average investor—is hardly likely to spend his afternoons in the gloomy vaults of the SEC library. It is not easy to get 8K and 10K reports.)

  The trouble with saying that most of the businesses report fairly is that it leaves the public with a question: Which are the ones that don’t? All the numbers look alike, and it requires a full-time professional accountant to ferret out all the nuances.

  It was not always this way; that is, there was not always this attention to hyping up current income. A generation ago, it used to be the other way around. There were far fewer stockholders, and the stockholders were much more likely to know the business, perhaps even to control it and hence to know the auditors. Management liked to pile up cash, as a reserve against leaner years. They did not want to report income. The stock market was sleepy; besides, the stock market valued assets and dividends, not reported income. If you reported big profits, your unions would ask for more money. The tax man would ask for more money. Your shareholders would expect a bigger dividend.

  Gradually this changed. The Internal Revenue Code of 1954 had some regressive features: tax shelters, investment credits, declining balance methods of depreciation. Labor unions stopped looking at the published data and based their demands on what they could get, not on what the figures showed might be a slice of the pie. For the most part, they got much of what they asked for, and the corporation simply raised its prices, and we were on the way to cost-push inflation.

  Shareholders began thinking that if you could get the stock to go up by plowing the dividend money back in, dividends were for old ladies. The corporation discovered that the more it borrowed, the higher the earnings and the higher the stock, so it began to leverage.

  The trend finally culminated in the late 1960’s when conservative managements were punished for their conservatism. If you carried your patents at zero, if you had written off everything and piled up the cash—if, in short, you had built up your assets—you were vulnerable to a company with no assets and a fast-moving, high-priced stock. Your own stock would have a one-shot jump when the offer would be made, but then you would be swallowed up into the company with the sexy paper, and history was to prove that those companies were ranking members of the booby list in the decline. Asset-rich insurance companies were a favorite target: thus Leasco took over Reliance Insurance, National General took over Great American, and so on. LTV, the vehicle of Jimmy Ling, took over the famous old packing firm of Armour, and the famous old steel company of Jones & Laughlin, in the famous “redeployment of assets” on the way to its troubles.

  Not all managements liked the trend, but once it got going, few were strong enough to buck it. “I wish to hell the stock market didn’t want to see the earnings go up all the time,” the chairman of a hotel chain told me. “Business just isn’t like that. Every year is not always bigger than the last year, and we have to bend things around a lot to get them to come out right.” Why not report it the way it is? “Then the stock would go down, and we’d be at a disadvantage vis-à-vis our competitors in hiring executives, making new hotel deals, and so on. If you could get everybody to go along at the same time, we’d do it.”

  Some people began to suggest that maybe reported profits weren’t the way to measure a company. Perhaps it should be cash flow, or return on investment.

  The worst sandbagging for an investor came not necessarily when the numbers danced around before he bought. That was nothing compared to the bath handed to innocent investors when the numbers were changed retroactively. Universal Widget says it earned 50¢ in 1969, $1 in 1970, and $1.50 in 1971. You buy in, and then they tell you, Sorry, we’ve changed our accounting; we didn’t earn that at all. Put a little d in front of those numbers for deficit. Let not the investor take off an hour for lunch; by that time the stock may have gone into one of those screeching dives that pulls out only at treetop level, à la Certain-teed and F & M Schaefer.

  Shouldn’t the investor get the same information as the SEC? Some of the accountants think that too much information would confuse the poor fellow. Philip Defliese, the managing partner of Lybrand, Ross Brothers & Montgomery, one of the Big Eight accounting firms, said thus: “Would you want things like maintenance and repairs in every annual report? Or rents and royalties? A layman has access—he can go to a library, most business libraries have these things. Or his broker can get them for him. If a man is going to invest and do a research job, then he should be doing the same kind of job the analyst is doing.”

  As sophisticated investors got bagged, some of them began to take shots at the accountants. Did not Peat Marwick certify the Penn Central? Was not that the distinguished name of Price Waterhouse on Minnie Pearl’s Fried Chicken, later Performance Systems, later busted? Was not that Arthur Young’s name on Commonwealth United? Did not the New York Stock Exchange itself sue Haskins & Sells, another Big Eight accountant, for certifying the busted New York Stock Exchange firm of Orvis Brothers? What did it mean to have a distinguished accounting name on reports?

  “Nothing,” said Thornton O’Glove, an accountant who writes a newsletter on accounting for a Wall Street firm. “The signature is worthless.”

  That is pretty strong stuff, so one does have to remember that the majority of companies play it quite straight. For those interested, there are articles galore (I have used some of them here) in the Financial Analysts Journal, in the accounting magazines, and in Barron’s and Forbes. John Childs of Irving Trust has written a very expensive, technical and complete little book called Earnings Per Share and Management Decisions.

  The ultimate responsibility in all of this was given by Congress to the SEC. Here is part of Section 19 of the original Securities Act of 1933, worth recalling just for the majesty of the Old Testament prose. It’s also worth recalling that the title states, “An Act to Provide Full and Fair Disclosure.” The italics are mine.

  The Commission shall have authority from time to time to make, amend, and rescind such rules and regulations as may be necessary to carry out the provisions of this title, including . . . defining accounting, technical, and trade terms used in this title. Among other things, the Commission shall have authority, for the purposes of this title, to prescribe the form or forms in which required information shall be set forth, the items or details to be shown in the balance sheet and earning statement, and the methods to be followed in the preparation of accounts, in the appraisal or valuation of assets and liabilities, in the determination of depreciation and depletion, in the differentiation of investment and operating income, and in the preparation . . . of consolidated balance sheets or income accounts.

  The Commission or any officer or officers designated by it are empowered to administer oaths and affirmations, subpoena witnesses, take evidence, and require the production of any books, papers, or other documents which the Commission deems relevant or material to the inquiry.

  So that is where the ultimate authority lies. But the SEC, whose payroll is an infinitesimal percentage of that of the CIA, could not possibly police all of American business. It bounced the reporting responsibility to business itself and to the accounting profession.

  But is accounting a profession? Could one be disbarred, or tossed out, for malpractice? For whom does the accountant work, the investor or the management?

  Most important: Is there any consistency in reporting? In 1938 The American Institute of Certified Public Accountants set up a Committee on Accounting Procedure “to narrow the areas of difference in corporate reporting.” In 1959 it set up the Accounting Principles Board to succeed that committee.

  The proponents of uniformity question whether any investor can make a decision when all the numbers are so different. How can the same Boeing 727 be depreciated over ten years by one airline and over sixteen by another? The defense says that it is management’s prerogative to decide, that accounting is an art, not a science, and too much rigidity wouldn’t be good either.

  The Accounting Principles Board put a committee to work on the metaphysical questions of accounting: What is “economic reality”? What is “current value”? What is “fair value” on a balance sheet? What should the objectives of financial reporting be? Can accounting provide what is needed? Should there be industry standards, with the discrepancies reported? Do differing circumstances justify the discrepancies?

  The sway of the Accounting Principles Board is far from firm even within its own profession, and it remains to be seen whether the clients will go along. Each reforming rule is greeted with squawks from the owners of various gored oxen, and in fact early in 1972 the Accounting Principles Board was sandbagged by its own clients when Congress passed an investment tax credit. Industry went in and lobbied for that credit to be allowed as a one-shot, one-year boost to profits; the accountants wanted the credit spread over the life of the equipment, and they were easily beaten.

  That dispute was followed by one over “full cost accounting” in the oil industry. We need not go into the harrowing details. Full cost accounting, said Stanley Porter, a partner of Arthur Young & Company and author of a book on petroleum accounting, would produce “instant earnings” for those companies that adopted it, and leave the more conservative companies facing the “erosion of their investment standing” by comparison. Yet full cost accounting spread like the Dutch elm disease.

  Within months, the Accounting Principles Board was just about out of business. The American Institute of Certified Public Accountants was devising another body, a Financial Accounting Standards Board, to replace it, which would include some non-accountants and which might be full-time and professional. So the whole business is still enveloped in clouds of dust.

  What is the investor to do? Short, of course, of getting the attention of his congressman—itself hardly likely, since accounting is rarely one of the gut issues in an election. I asked the question of many of the concerned people. Professor Abraham Briloff of the City University of New York thought accountants should subscribe to a Nuremberg Code and should refuse to carry out orders that were improper or morally wrong. One member of the Accounting Principles Board said to me: “We are the Establishment, and if we do not work quickly to change things, the whole thing is going to come down.” David Norr, a Wall Street member of that board, wrote: “Accounting today permits a shaping of results to attain a desired end. Accounting as a mirror of activity is dead.” Even the legal profession is wary, lest “generally accepted accounting principles” not represent full enough disclosure. The Review of Securities Legislation, citing SEC v. Banger Punta Corp., U.S. v. Simon, and Gerstle v. Gamble-Skogmo, warned: “Counsel must beware of blind reliance on the adequacy of financial statements, both as a whole and in particulars. There are many situations in which such statements, even though competently and carefully prepared, and in accordance with generally accepted accounting principles, must be supplemented extensively lest the statements themselves become instruments of deception.”

  Still another board member worried that Ralph Nader and the forces of “consumerism” might seize the issue, although, he said, “the public itself doesn’t give a damn. The public is a greedy lot: give them two years of a good market and they’ll be back.” Another professor of accounting wanted the professional consumers of the financial information—institutions and their analysts—to refuse to buy the production until standards were satisfied.

  The charges of the critics still echo, and they include such phrases as “fiscal masturbation,” “massaging the numbers” and “corporate fandangles.” The head of one of our major drug companies put it quite succinctly: “One good accountant is worth a thousand salesmen.”

  And yet, and yet—all of these exceptions take for granted that there is truth and it can be made to work. Even the accountants’ critics can sometimes see progress, though they then say it’s not fast enough. If you look to Europe or Japan, the accounting is nowhere near as full nor as precise. In Britain, whence much of contemporary accounting grew, some of the work done is even better, but it is done on British companies with their own sets of problems.

  Accounting should chart the ebb and flow of activity so that non-accountants can take it for granted. It is scarcely fair to ask everybody to be an accountant. Yet the way things are, few investors will be able to unravel the nuances themselves. The accounting profession should earn the investor’s confidence, but in the meantime an individual investor has to get help from the brokers who get commissions from him. Somewhere in the brokerage firm there have to be sophisticated buyers of information.