Speech by SEC Commissioner:
Remarks Before AMCHAM EU
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
September 27, 2006
Thank you for your kind introduction. I am honored to have the opportunity to address you and to share the dais today with Monsieur Delsaux, who with his colleagues at the European Commission's Internal Market and Services Directorate has devoted so much time and energy to fostering the free movement of capital across national borders.
I appreciate Amcham's work in this area as well. The voices of American companies that are integrated into the European business environment are critical in helping to shape the regulatory system on both sides of the Atlantic. Having lived and worked in Europe for a time during my early legal career, I too am committed to strengthening trans-Atlantic ties. Let me start by saying, as I am required to do, that the views I express here are my own and do not necessarily reflect those of the Securities and Exchange Commission or my fellow Commissioners.
I understand that you just finished a session in which you discussed whether accounting and auditing standards are a barrier to raising transatlantic capital. To the extent that you reached a definitive conclusion, I hope that, on balance, you decided that they do not form an insurmountable barrier. Indeed, I hope that you will agree with me that the strides that have been taken in the past year bode well for accounting and auditing standards' serving as a basis for closer interrelationships, rather than divergence, of our capital markets.
The transatlantic capital market of today and the even stronger one that I anticipate for the future are rooted in a close relationship between Europeans and Americans. As we all know, this is a relationship that was forged through hundreds of years of history, many of which were difficult years. Today, that relationship is a healthy one that is able to withstand the inevitable disagreements that arise in the course of confronting a whole host of cross-border issues. The strength of our relationship is evidenced by the interconnected nature of our economies. We invest in and trade with each other's economies more than we do with any other economy. The two continents liberally exchange tourists, students, and employees. We work together to confront the world's many challenges. As President Bush said when he was visiting Brussels last year:
In a new century, the alliance of Europe and North America is the main pillar of our security. Our robust trade is one of the engines of the world's economy. Our example of economic and political freedom gives hope to millions who are weary of poverty and oppression. In all these ways, our strong friendship is essential to peace and prosperity across the globe -- and no temporary debate, no passing disagreement of governments, no power on earth will ever divide us.1
The cooperative spirit with which the European Union and United States approach one another generally has helped us to overcome or mutually tolerate the differences that we have. This cooperative and tolerant spirit has already proven invaluable in the realm of accounting and auditing standards.
The new EU-wide mandatory application of International Financial Standards has ushered in an important period in the history of accounting. As European companies transition to IFRS, many on both sides of the Atlantic are watching. This is the time during which the groundwork must be laid to ensure high-quality standards and consistent application of IFRS across all of the nations in which it is used.
Many are working to ensure the success of IFRS. The International Accounting Standards Board strives to achieve high-quality standards with input from the full range of interested parties. Issuers, of course, are on the front lines and face the most difficult challenge of applying IFRS consistently and appropriately in their particular circumstances. I hope that companies are working together in this effort with other similarly situated companies. Accounting firms play a critical role in helping to achieve consistent application of IFRS across clients, industry groups, and national borders. To do this, they need to be internally consistent and talk to one another so that differences of interpretation do not develop firm-to-firm. National regulators need to resist the impulse to develop a nationally specific version of IFRS. International organizations - the Committee of European Securities Regulators and IOSCO in particular - are facilitating consistent application through, among other things, the development of databases of IFRS decisions by members.
We at the SEC are actively participating in the efforts to establish IFRS as a viable and reliable set of accounting standards. Our staff is currently working with regulators at CESR in reviewing the financial statements of foreign issuers that have filed using IFRS. These filings will enable us to assess IFRS. It is one thing to see a theoretical standard, and quite another to see how it is applied across a broad range of companies.
I have never believed that it is necessary to impose a single set of accounting rules on all participants in the global marketplace in order to allow competition across borders. In fact, due to differences in culture, legal systems, and liability regimes, true equivalence in accounting standards is probably be an impracticable objective, at least in the foreseeable future. What is critical, however, is that accounting standards be clearly stated and evenly applied by all nations and companies adopting those standards. Moreover, financial reporting standards must be implemented in such a way that they succeed in serving their intended purpose of protecting investors.
The coherent, consistent application of IFRS is important to the elimination of the reconciliation requirement in the United States. It will take us some time to assess how IFRS is being implemented and enforced, but I am optimistic that we will complete our assessment and be able to determine that the reconciliation requirement is unnecessary well within the 2009 goal for reconciliation. Our new Chief Accountant, Conrad Hewitt, is committed to working to achieve this objective as quickly as possible.
I am keenly aware that shareholders ultimately bear the costs of reconciliation, which can be considerable. For this reason, I am encouraged by what appears to be decreasing support in Europe for requiring reconciliation for U.S. issuers that currently use GAAP in their EU filings. Requiring U.S. companies to reconcile their U.S. GAAP financial statements to IFRS would undermine our own efforts towards mutual recognition by affirming a lack of equivalence just when we on our side of the Atlantic are trying to show that there is sufficient equivalence to justify ending the reconciliation requirement. We want to make sure that IFRS succeeds. Of course, U.S. GAAP is already an established standard that has proven itself to investors over time. The need for reconciliation disappears when IFRS shows itself to be, like GAAP, a consistently applied, high quality set of accounting standards. It is in everyone's best interest to achieve the elimination of the reconciliation requirement as quickly as possible.
In the meantime, the SEC will work with its European counterparts to improve financial reporting for the benefit of investors everywhere. Just last month, the SEC and CESR issued a joint work plan, which sets forth goals for cooperation between the regulators.2 The work plan focuses on the development of high quality accounting standards and achieving consistency and quality for IFRS. The plan sets forth practical ways of achieving this through formalizing transatlantic channels by which information and experiences with IFRS and US GAAP are shared and specific implementation matters are discussed. The work plan, which will help to form a vital, transatlantic working relationship between regulators, grew out of a meeting between CESR Chairman Arthur Docters van Leeuwen and SEC Chairman Christopher Cox last December.
Chairman Cox's commitment to the success of IFRS is one component of his larger view of the importance of a strong transatlantic dialogue between regulators. The work plan also covered two other items to which the Chairman is committed: enhancing the quality, transparency, and usefulness of financial reporting through the use of information technology. Since coming to the SEC, Chairman Cox has advocated the development and expanded use of interactive data technology, which will ease comparisons across companies. The work plan also provides for cooperation between SEC and CESR in establishing more effective risk-based regulatory programs.
The deepening of the cooperation between the SEC and CESR is a very constructive development that will positively influence accounting and auditing practices in the U.S. and in Europe. In addition, both GAAP and IFRS are likely to benefit from the efforts of the Financial Accounting Standards Board and the International Accounting Standards Board. The FASB and IASB are working to eliminate differences between U.S. GAAP and IFRS consistent with their Norwalk Agreement, the principles of which were reaffirmed in a Memorandum of Understanding entered into earlier this year.3 The FASB and the IASB have committed to work toward a common set of high-quality accounting standards. Although this is a long-term goal, I have heard encouraging reports about the level of cooperation between the two accounting boards.
One other area in which regulators are reaching out to one another across borders is the regulation of audit practices. The Public Company Accounting Oversight Board was established as part of the Sarbanes-Oxley reforms to oversee public company audits in the United States. Any accounting firm that audits one or more U.S. public companies must register with the PCAOB. This includes non-U.S. accounting firms with U.S. clients. The PCAOB is an unusual entity, structurally speaking. Although it has powers that make it look like a government regulator, it is a nonprofit corporation that pays its Board members and employees salaries that are intended to rival those of their counterparts in the for-profit sector. Because of the unusual nature of the PCAOB, the SEC is responsible for overseeing it.
The PCAOB is charged with, among other duties, inspecting the accounting firms that are registered with it. Among those firms are more than 600 non-U.S. firms in more than 80 countries. Needless to say, inspecting accounting firms outside the U.S. will entail a high degree of cooperation with foreign regulators. It is incumbent upon the SEC to ensure that when the PCAOB plans and conducts its inspections outside of the United States with a proper appreciation for the fact that many of these firms are subject to regulation by their own national regulators. The PCAOB must be particularly sensitive to instances in which firms face overlapping, and potentially conflicting standards from their national regulators.
The subject of accounting and audit standards is just one area of many in which the SEC is working to enhance transatlantic cooperation. I will address several other issues briefly now, but I would be happy to discuss any of these at greater length later during the question-and-answer session.
The SEC is actively considering amendments to its deregistration rules. As you know, this has been an area of acute concern for European companies. There is a feeling that a decision to list in the United States can never be reversed. Under current rules, a foreign issuer may terminate its Exchange Act registration and reporting obligations only if fewer than 300 record holders of the issuer's securities are U.S. residents. Foreign issuers may find it difficult to meet this standard even if there is relatively little investor interest in the United States. I will note, however, that in the past year more than 100 issuers have deregistered under the current strict standard.
Regardless of the number of companies that could deregister under current rules, it is likely that uncertainty about the litigation and regulatory climate has dissuaded non-U.S. companies from going to the U.S. to raise capital. That problem is only exacerbated if issuers are afraid that they cannot reverse course and deregister if the listing does not meet their expectations. So, in December of last year the Commission published for comment a proposed rule concerning a foreign private issuer's termination of its reporting requirements.
Many of you are probably familiar with that proposal, so I will only describe it briefly as it applies to equity securities. First, an issuer would have to meet certain prerequisites, including having filed all required reports in the U.S. for the preceding two years, not having sold its securities in a U.S. offering during the preceding 12 months, and having maintained a listing on an exchange in its home country during the preceding two years. With that as a basis, an issuer would have to meet one of a set of alternative benchmarks, depending on whether it is a "well-known seasoned issuer," or WKSI. WKSIs are generally large multi-national companies. A WKSI generally could deregister if the U.S. trading in its securities is 5 percent or less of the trading in its home market and U.S. residents hold no more than 10 percent of the WKSI's worldwide public float. For all other companies (the non-WKSIs), as well as for WKSIs if they wish, a company would be able to deregister if U.S. residents hold no more than 5 percent of the issuer's worldwide public float. Under the proposal, companies would still be able to use the current 300-shareholder rule if it suits them better. The proposal also would require foreign issuers that are deregistering to publish on their Internet web site or some other public electronic medium English translations of materials that they distribute in their home country.
We received more than fifty comment letters, many from European companies, in response to our proposal. These comment letters urged us to liberalize the rules more than we had proposed. I, for one, do not think that our proposal addresses the situation as well as it should, and I have much sympathy with many of the comments raised. In particular, I have great sympathy for the frequent theme of the comment letters that qualified institutional buyers, whose expectations and needs likely are radically different from those of retail investors, should be excluded when counting US shareholders. I like the philosophical consistency of that approach with our rules that in so many other areas draw distinctions between retail and institutional investors. If an investor has not availed himself of the US markets to purchase the securities in the first place, why should we tie the issuer to the US markets on his behalf? We should refrain from having an extra-territorial effect to our rules. Alternatively, the European Commission comment letter requested that we increase the maximum percentage of US shareholders to 25%. That may also be a viable option, although a percentage of that size may be somewhat controversial.
We are now considering whether and how to modify the proposed approach in light of the comments that we have received. The need for flexibility for issuers must be balanced, of course, against the expectations of American equity investors. In my mind, the proper approach will allow issuers to deregister unless their shareholder base includes a large number of U.S. residents who have an expectation of being able to trade in the U.S. The exact contours of such an approach are difficult to specify given the difficulty in assessing the characteristics of shareholders.
A number of commenters expressed concern that the proposal did not go far enough to alleviate the situation since so few companies would meet the new tests. Frankly, estimates of the numbers of eligible issuers are far from certain. I have heard numbers ranging anywhere from 5 percent to 26 percent of foreign issuers could deregister under the proposal. In any event, the consistent refrain from Europe is that the proposal does not go far enough. We take your concerns seriously and are diligently working to devise an approach that takes them into account without compromising our obligation to protect the interests of American investors.
Deregistration brings me to one final issue. Calls for a liberalization of our deregistration rules intensified in the aftermath of Sarbanes-Oxley. The real culprit seems to be Section 404 of the Act. As you know, Section 404 of the Act requires management to complete an annual internal control report and requires the company's auditor to attest to, and report on, management's assessment. Despite its worthy objectives, implementation of that section has produced many unintended consequences, at great cost and tribulation for companies in the U.S. and abroad. The costs, frankly, took us by surprise.
The SEC is committed to addressing those implementation problems. As evidence of this commitment, the SEC has hosted over the past two years two roundtables to hear what went wrong and how the process can be improved. In addition, the SEC has given smaller companies and foreign issuers more time to comply with Section 404 requirements. Most recently, we granted relief from Section 404 to accelerated foreign private issuers that are not large accelerated filers by extending for a year the deadline for an auditor's attestation report. The auditor attestations will first be required in annual reports for fiscal years ending on or after July 15, 2007. These companies must include management assessments of internal controls in their annual reports filed for their first fiscal year ending on or after July 15, 2006.
We also proposed to extend the filing deadlines for non-accelerated filers, both foreign and domestic. Under the proposed extension, they would have to file their management assessments for the first time for fiscal years ending on or after December 15, 2007 and the auditor's attestations on those assessments would first be required for fiscal years ending on December 15, 2008. The SEC also proposed transition relief for newly public companies, including foreign private issuers listing on a U.S. exchange for the first time. A newly public company would not be required to provide either a management assessment or an auditor attestation report until it has previously filed one annual report with the Commission. In announcing this relief, the Commission estimated that 60% of the approximately 1,200 foreign private issuers will benefit from the Section 404 relief.4 The remaining foreign private issuers are "large accelerated filers," to which both Section 404 requirements already apply.
Many of the problems associated with Section 404 stem from the audit standard adopted by the PCAOB to govern the auditor's role in opining on an issuer's internal controls. The standard has made it difficult for auditors to employ professional judgment in assessing internal controls and encouraged them instead to use a time-intensive bottom-up approach. We hear too many stories of excessive documentation, bottom-up audits, and overly conservative material weakness determinations. The resulting process diminishes the risk of being second-guessed, but does so by foreclosing the use of reasoned judgment.
The PCAOB is working now to revise the relevant audit standard so that it is shorter, simpler, and allows for more efficient application. As I mentioned earlier, the PCAOB is the body that is responsible for overseeing audits of U.S. issuers and the auditors that carry out those audits. As I also mentioned, the PCAOB is not a governmental entity, but rather is subject to the oversight of the SEC. Accordingly, our office of Chief Accountant is working with the PCAOB on revising the audit standard. The process for overseeing the work of the PCAOB is not without its limitations, which may make it difficult for the SEC to shape the PCAOB's final standard with the degree of precision that I would like. Nevertheless, I am committed, if necessary, to employing all of the SEC's oversight tools to ensure that the standard gets fixed.
Importantly, the SEC is simultaneously working on guidelines of our own for management. Absent such guidance, companies have been at the mercy of their auditors and have incurred great costs in satisfying seemingly unreasonable demands from auditors operating under the constraints of the PCAOB's unwieldy audit standard. By providing management with guidance of its own, we hope to restore a healthy balance to the process.
You have been a very patient audience. I welcome your continued active involvement in our issues, including your questions and comments. My phone and office are always open to you, if you are inclined to pay for an international call or fly to the U.S.! I look forward to hearing Monsieur Delsaux's response and then I would be happy to answer address your comments and questions.