Speech by SEC Commissioner:
Remarks before the Conference on SEC Regulation Outside the United States
Commissioner Kathleen L. Casey
U.S. Securities and Exchange Commission
March 6, 2008
Thank you, Mark, for that kind introduction, and good morning. It is always a pleasure to be in London. I understand that it has become somewhat of a tradition to have a member of the Securities and Exchange Commission deliver the keynote address at this conference. I am honored to help continue this tradition today.
I know former Commissioner Campos gave the keynote last year, so I would like to go ahead and lower expectations right away by saying that Roel's a tough act to follow. I also need to give the standard disclaimer that the views I express today are my own and do not necessarily represent those of the Commission or its staff.
Many of the initiatives Commissioner Campos highlighted last March remain live on our agenda, and the Commission has made considerable progress on all of them.
Since then, the Commission adopted final rules facilitating more effective and efficient deregistration by foreign private issuers.
The Commission adopted new management guidance and together with the Public Company Accounting Oversight Board approved a new auditing standard in furtherance of our efforts to reduce costs and burdens of Section 404. We recently proposed extending the deadline for small issuer compliance with the audit requirement of 404(b) and are now looking at implementation issues in addition to conducting a cost/benefit study of the changes we adopted.
Last fall, the Commission eliminated the reconciliation requirement to US Generally Accepted Accounting Principles for foreign private issuers that file in International Financial Reporting Standards as issued by the International Accounting Standards Board. And we are now actively considering whether, how and when US issuers should be able to choose between filing in IFRS and US GAAP.
Mutual recognition was still largely a theoretical discussion early last year. Now, the Commission is actively developing core principles for mutual recognition of comparable regulatory regimes and undertaking discussions with foreign regulatory counterparts on what such frameworks would contemplate on a jurisdiction-by-jurisdiction basis.
What a difference a year makes.
As you can see, the SEC has been very busy over the past twelve months, and these are only some of the issues currently before the Commission. You are fortunate to have senior SEC attorneys John White, Scott Friestad, Gene Gohlke, Robert Plaze and Matthew Daigler here as well, to make it abundantly clear just how active the Commission has been and how much we hope to accomplish in the year ahead.
Section 404 of the Sarbanes-Oxley Act
I am extremely encouraged by the changes that the SEC and the PCAOB have made to improve the implementation of Section 404. The SEC's adoption of management guidance last May and its approval of the PCAOB's Auditing Standard No. 5 in July represented the culmination of over two years of work by the Commission, the PCAOB, and its respective staffs. The goal of both the PCAOB and the SEC in making these improvements, and aligning their approach, was to reduce the excessive compliance costs and burdens while also ensuring a more effective and efficient assessment and audit of issuers' internal control over financial reporting.
As such, the revised standard provides a number of benefits including being principles-based, less prescriptive, directing auditors to focus on those matters that present the greatest risk to a company's financial reporting, and enabling auditors to tailor and scale the audit to a company's particular facts and circumstances, such as size and complexity.
Equally important to the development and adoption of an improved auditing standard is the manner in which it is implemented by auditing firms and the PCAOB. To that end, the PCAOB's inspections program will monitor whether audit firms are implementing the new auditing standard in a way that facilitates the achievement of the intended benefits. The PCAOB has indicated that it is training its inspections staff and adjusting its inspection approach on the significant changes expected under AS 5. As part of our oversight capacity of the PCAOB, the SEC will be monitoring audit firms' implementation of AS 5. In addition, the SEC will be monitoring the PCAOB's approach for inspections under AS 5 to ensure it is inspecting audit firms in a manner consistent with achieving the intended benefits.
Ultimately, the Commission's success in making the internal control provisions more efficient and effective for all issuers will be measured by our ability to alter behavior, and this will depend on how the SEC and PCAOB examine and enforce the law for compliance and how issuers and auditors view the risk of exercising greater judgment under new guidance and a revised auditing standard.
Earlier this year, the Commission voted unanimously to propose a one-year extension of the Section 404(b) auditor attestation requirement for smaller companies, which would allow time for completion of a cost-benefit study by the SEC's Office of Economic Analysis (OEA). The study will give us the opportunity to ensure that the investor protections of Section 404 do not impose disproportionate burdens on smaller companies. The OEA study, which should be completed by this Fall, will consist of two main parts — a Web-based survey of companies that are subject to Section 404 and in-depth interviews with companies, including companies just coming into compliance. This methodology will enable the Commission to gather data from a large cross-section of companies and analyze more detailed information about what drives costs and where companies and investors derive the benefits.
International Financial Reporting Standards
Significant milestones were reached last year in the SEC's ongoing effort to promote and achieve a single set of high-quality global accounting standards. Consistent with our 2005 roadmap, the Commission approved the elimination of the reconciliation requirement to U.S. GAAP for foreign private issuers that file in IFRS as issued by the International Accounting Standards Board. The Commission took this action only after certain preconditions were met.
First, the Commission needed to be satisfied that there was a robust process towards convergence. Second, we needed assurance that IFRS as published by the IASB was being consistently and faithfully applied. And third, we needed to have confidence in the IASB and its oversight by the IASC foundation.
On all of these issues, the Commission was able to reach a positive conclusion and, ultimately, determine that eliminating the reconciliation requirement would further our broader goal of achieving greater convergence and a single set of global accounting standards.
The Commission's consideration of IFRS continues to focus now on whether U.S. issuers should similarly be able to choose between filing in IFRS or U.S. GAAP. The Commission issued a concept release in August and held roundtables in December probing this question.
The concept release seeking information about the extent and nature of the public's interest in allowing U.S. issuers to prepare financial statements in accordance with IFRS as issued by the IASB generated many thoughtful responses. The comment period closed on November 13, 2007, and we have been carefully reviewing all of the comments submitted.
The roundtables also provided the Commission with extremely valuable information. The professional staffs of the Division of Corporation Finance, led by John White, and the Office of Chief Accountant, led by Conrad Hewitt, did an outstanding job organizing two days of highly informative panels. The first roundtable focused on the general question of whether U.S. issuers should be permitted to use IFRS. The second roundtable focused on how to make the transition to IFRS. Each roundtable consisted of two panels, one with a U.S. markets perspective and another from the perspective of global markets.
While there were a range of differing views expressed on key particulars and necessary preconditions common to allowing IFRS use in the U.S., it was interesting to observe agreement — particularly given the diverse constituencies represented — on important fundamental issues. For example, everyone agreed that the ultimate goal should be a single set of high-quality, globally accepted accounting standards. There was also a general belief that the uniform global standard will ultimately be IFRS, not U.S. GAAP. And finally, panelists suggested that a roadmap should be established to transition U.S issuers to IFRS. Although there are significant challenges ahead that will require strong leadership from all stakeholders, the roundtables offered encouraging news with respect to the level of agreement concerning some threshold considerations. The Commission will remain highly engaged in this area and I expect another productive year ahead.
Over the past year, there has been a great deal of focus and discussion on the concept of a mutual recognition approach by the SEC. The Commission and its staff have been exploring the development of a collaborative process to recognize regulatory regimes administered by securities regulators that share similar regulatory philosophies rooted in strong investor protections and underpinned by robust oversight and enforcement.
I remain strongly supportive of our efforts to develop and implement a mutual recognition regime. Global markets require more cooperative regulatory frameworks among like-minded national regulators. Indeed, we increasingly must rely on each other to effectively address market problems, and continue to meet our shared objectives of promoting strong investor protection and market efficiency.
vThe Commission held a very informative staff roundtable on mutual recognition last June. Staffs of the Office of International Affairs, led by Ethiopis Tafara, the Division of Trading and Markets, led by Erik Sirri, and the Division of Corporation Finance, led by John White (I have to mention him again — after all, he is appearing on three panels today), did a terrific job organizing the roundtable.
Again, I believe the roundtables were extremely helpful in guiding the Commission's consideration and helped reinforce key underpinnings for a mutual recognition framework. I anticipate that the Commission will seek to lay out more clearly in the near term its view on next steps for mutual recognition.
As Chairman Cox has made clear on numerous occasions, most recently in a joint statement issued with European Commissioner for the Internal Market and Services Charlie McCreevy, this remains a high priority for the Commission and preliminary discussions are already being undertaken to lay the groundwork for more formal action by the Commission.
Credit Rating Agencies
The last subject I will discuss today is credit rating agencies. They, of course, have been widely criticized for issuing inaccurate ratings in the structured finance area. A number of explanations have been offered for this performance. For our purposes here this morning, however, it is not necessary to identify the precise reasons for this underperformance — although I would note that the Commission, in collaboration with many other regulatory bodies, is actively engaged in such a review and analysis. Instead, I would like to discuss the statutory framework in the U.S. and suggest core principles that should guide the Commission in its ongoing review of rating agencies and any reforms we might seek to make to our rules.
In determining the appropriate SEC role with respect to credit rating agencies, a necessary starting point is the federal statute that we must administer. The text and legislative history of the Credit Rating Agency Reform Act, enacted in 2006, makes clear that one of the primary purposes of the law was to enhance competition in the highly concentrated rating industry.
The rating industry has long suffered from an absence of competition. It is dominated, and has been for decades, by three large firms that share the vast majority of revenues — approximately 90-95 percent. Longstanding concerns have been raised that this oligopoly has led to inferior ratings quality, oligopolistic pricing power, and substandard innovation. Many believe that increased competition in the rating industry, like in other industries, will improve quality, lower prices, and enhance innovation. I do not think that this is a farfetched idea, by the way.
To promote competition, the Act established a transparent registration system in place of the longstanding SEC-staff designation system. The old system granted "nationally recognized statistical rating organization" status only to those rating agencies that were, as the term suggests, "nationally recognized." This NRSRO designation became extremely valuable over time, as regulatory actions required market participants, for compliance purposes, to use only those ratings issued by an NRSRO. As a result, potential competitors to the entrenched incumbents could not get nationally recognized without first having the designation. And they could not get the designation without being nationally recognized. This "Catch 22," a hallmark of the designation system, helped to stifle competition ever since the dominant firms were selected as the original NRSROs in 1975.
The Act's registration system eliminated these artificial barriers to entry. As a result, rating agencies that want to become NRSROs today simply submit a completed application that must essentially be approved or disapproved by the Commission within 90 days. It is now a fair and transparent process. Because the Act defines the term "NRSRO,"1 potential new entrants know exactly what information must be submitted and they have the assurance that we will act on their application within a specific time frame.
Under the Act, the SEC for the first time has clear authority to supervise the rating agencies. The Commission has the authority to prevent NRSROs from issuing "credit ratings in material contravention" of the procedures disclosed in their application and subsequent reports. The Commission may censure, limit, suspend, or revoke registration of the NRSRO for any of a variety of specified types of misconduct. Importantly, the Commission has authority to conduct a robust inspection and examination program to ensure that the rating agencies are operating in a manner consistent with their disclosures and the federal securities laws.
In response to the concerns that rating agencies failed to appropriately warn investors in a timely manner about the risks in structured financial products, in particular mortgage-backed securities, SEC staff — led by the Division of Trading and Markets, and including the Offices of Compliance Inspections and Examinations and Economic Analysis — has been conducting a comprehensive review of the three rating agencies that dominate the industry. This review includes on-site visits in New York and is focused on whether the rating agencies diverged from their stated methodologies and procedures for determining credit ratings in order to issue higher ratings. The staff is also focusing on whether the rating agencies followed their stated procedures for managing conflicts of interest. The Commission will receive preliminary reports from these examinations as early as the end of this month, with a final report expected by early summer.
The Commission's work in this area also involves close coordination and collaboration with the President's Working Group on Financial Markets, the International Organization of Securities Commissions, and the Financial Stability Forum. We are actively participating in all of these important and deliberative bodies.
The Commission intends to consider additional rules this year under the authority granted by the Credit Rating Agency Reform Act. In my view, our rulemaking effort should be guided by the following principles. First, we must be faithful to the spirit and letter of the Act, in particular Congress's intent of promoting competition in the rating industry. Second, we should reduce, to the greatest extent possible, any undue reliance on credit ratings. At a minimum, this means the Commission should carefully reevaluate all the references to NRSRO ratings in our rules. Third, we should not favor one business model — qualitative or quantitative, issuer-paid or subscriber-paid — over another. Finally, and this is related to the first principle, we should not attempt to micromanage the industry with symbolic gestures. Doing so would only add costs, offer at best negligible benefits, and likely have the unintended consequence of further enhancing the franchise of the dominant and entrenched incumbents.
These are just some of the many issues that the Commission will be focused on this year. As mentioned earlier, you have terrific representatives from the Office of Compliance Inspections and Examinations and all four of the Commission's divisions here today to discuss these and many other matters on our agenda this year. I hope, and expect, that you will find their presentations highly informative.
The Commission remains deeply committed to making continued progress in all of these key areas. Many of them are not discrete initiatives, but rather reflect broader and continued commitments to regulatory cooperation and collaboration with our international counterparts in the future.
It is my hope that next year's conference will once again be able to highlight the progress the SEC has made on all of these fronts. I want to thank Mark again for this opportunity to be with you today. Please accept my best wishes for a successful and productive conference. Thank you.