Speech by SEC Commissioner:
Remarks Before the Association Française De Gouvernement D'entreprise (French Association Of Corporate Governance)
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
June 15, 2006
Good evening, ladies and gentlemen. First, I should like to thank Monsieur Massie for having organized this dinner and for having chosen the marvellous setting of the Salon-Club of the Maison des Arts et des Métiers in Paris. Because of conflicting official commitments, I must be in Colorado tonight. Unfortunately, I do not have the gift of omnipresence. But, thanks to video technology, I can at least be with you to share some thoughts. If I could do so, I would be present in Paris to talk to you in person.
Before I go further I should mention that the comments I am about to make are my own and do not necessarily reflect official SEC policy or the opinions of my fellow Commissioners.
Of course, the news of the moment is the merger between the New York Stock Exchange and Euronext. As I am sure you know, the NYSE Group made its initial bid on May 22. The combined entity will be quite impressive. It is projected to have average daily trading volume of $100 billion and a market capitalization of all the listed companies of approximately $27 trillion.1
The New York Stock Exchange's plan, as I understand it, is to have quotes at the same time in both New York and Europe with the intention that foreign issuers whose shares are quoted only in Europe will not be subject to American regulations. Companies quoted in France, for example, would come under French but not American regulatory review.
There has, not surprisingly, been quite a bit of discussion of this merger in the financial press. People have long anticipated that the NYSE would undertake some transaction to expand overseas, but this particular move into continental Europe appears to have been largely unexpected. The SEC will be working in close collaboration with our counterparts in Europe and around the globe regarding the procedure of regulating exchanges that span national boundaries. I have every expectation that we will reach well reasoned and practical solutions.
But it is another issue that has elicited the most vociferous debate: Why does the New York Stock Exchange feel compelled to achieve a European presence at this time? The directors of both companies clearly see business synergies and opportunity.
Some commentators have argued that increased regulation in America required the New York Stock Exchange to seek an overseas presence. Have increased costs in the American regulatory environment put pressure on the NYSE to diversify its customer base? Are issuers 'voting with their feet' because the costs of the new regulations outweigh the benefits of improved investor protection afforded by the enhanced regulatory regime?
I have no answers to these questions, but I am worried by some of the empirical evidence. Consider: According to the Wall Street Journal, in the year 2000 nine out of every 10 dollars raised by foreign companies through new stock listings were done in New York, but by 2005 the numbers had reversed so that nine out of every 10 dollars were raised outside of America.2
I am a strong advocate of the idea that any government regulation must provide at least as much benefit as it extracts in compliance costs. This is particularly true of regulations enforced by the SEC for, while many people regard the SEC as a prosecutorial agency, we are also charged by the American Congress with ensuring that the securities markets provide an efficient environment. The Sarbanes-Oxley Act will be a success if the benefit to investors of more reliable corporate financial reports outweighs the costs of compliance with the law.
It is indisputable that everyone, including the SEC, completely underestimated the costs involved in the 404 process. Much of the cause of the higher costs rests on the Public Company Accounting Oversight Board's Auditing Standard Number 2 (AS2), a document of 300 pages (without counting the hundreds of pages of "guidance" issued by the PCAOB), which was issued to govern the implementation of Section 404 by auditors.
It is widely acknowledged that AS2 has caused corporate management and auditing firms to be much too conservative in exercising their judgment. We hear too many stories of how people seem to be driven by the impulse to document virtually every process in an effort to appear to be thorough and to respond in advance to all eventual questions that might be raised by regulators and litigators. We hear too many stories of companies that have to document and produce process charts of tens and even hundreds of thousands of key internal controls. The PCAOB itself has acknowledged that there were problems with the implementation of AS2, including a tendency to employ a bottom-up approach, which resulted in the expenditure of "more time and effort than was necessary to complete the audit."3
I am confident that the Sarbanes-Oxley Act can offer considerable benefits to shareholders. The emphasis on good controls over financial reporting is laudable. Section 404 focuses on the integrity of financial information and seeks to give shareholders additional insight into the credibility of financial statements. The principle is that investors would be encouraged to augment their scrutiny of financial statements of a company that has been found to have "material weaknesses" in the internal controls around the processes that produce its financial statements. Our job as regulators is to ensure that the law's goal of improving the reliability of corporate financial reports is achieved in a rational and realistic manner, and that definitions of terms such as "material weaknesses" actually have meaning.
There has been much discussion within and outside of the SEC regarding ways in which individual provisions of the Sarbanes-Oxley Act may be imposing a greater cost than was anticipated, or than may be justified by the benefits imparted to investors. Reducing these costs is essential. Reflecting this, the SEC and other agencies are actively seeking approaches that would mitigate the costs of implementing Section 404. I can assure you that in the coming months, the SEC and the PCAOB will be considering steps to cut the costs while maintaining the benefits of Section 404.
On the 17th of May, following an all-day conference that we held regarding experiences with Section 404 implementation, the SEC and the PCAOB announced plans to further improve the rules regarding Section 404. Audit Standard No. 2 will be revised and the SEC will monitor the PCAOB's efforts to improve Section 404 oversight. We also announced an additional postponement of Section 404 for smaller filers, including smaller foreign private issuers, such that they will now be required to comply with the management assessment required by Section 404 for fiscal years beginning on or after December 16, 2006.
In the next few weeks, we expect to solicit views on the management assessment process to ensure that the guidance we ultimately propose addresses the needs and concerns of public companies. We will also seek input on the appropriate role of outside auditors in connection with the management assessment required by Section 404, and on the manner in which outside auditors provide the required attestation. I should note here that Canada recently decided against having outside auditors review management assessments.
We also anticipate that we will issue guidance to management to assist in its performance of a top-down, risk-based assessment of internal control over financial reporting. To ensure that this guidance is of help to non-accelerated filers and smaller public companies, we intend that this guidance will be scalable and adaptable to their individual circumstances.
The PCAOB will propose revisions to AS 2 that will ensure that auditors take a top-down approach to their audits and that they use a risk-based approach. The PCAOB will also revisit and clarify what, if any, role the auditor should play in evaluating the company's process of assessing internal control effectiveness.
We will continue to work on a more rational approach to implementing Section 404. If we are able to address the Section 404 problems and evaluate whether there are other areas where the cost of complying with Sarbanes-Oxley can be reduced without diminishing investor protection, we will begin to address the concerns expressed by international as well as domestic issuers.
At the SEC, our mission is to facilitate capital formation not just for companies headquartered in the United States, but for those companies outside the country as well. That is why the SEC must be ever concerned about maintaining the United States capital markets as an attractive place for investors from any country to invest their capital. We must ensure the integrity of our markets so that investors have confidence that they will be treated fairly. At the same time, our regulations must not price those very investors out of our markets through burdensome regulations.
I ask for your help in finding this balance. We have an open door and an open mind policy at the SEC. I encourage you to let me and the other Commissioners know of your concerns. We are ready to listen to all of your submissions that can help us in our effort to transform the Sarbanes-Oxley Act into the shareholder protection tool that it was intended to be.
Thank you, ladies and gentlemen, for your attention. Please accept my wishes for an excellent evening.