Speech by SEC Chairman:
'The Future of International Standards and Cooperation In Light of the Credit Crisis'
Chairman Christopher Cox
U.S. Securities and Exchange Commission
FEI 2008 Current Financial Reporting Issues Conference
New York, New York
November 18, 2008
Thank you for that kind introduction. You've had quite a morning with the SEC already, having heard from Con Hewitt [SEC Chief Accountant], John White [SEC Director of the Division of Corporation Finance] and Jim Kroeker [SEC Deputy Chief Accountant] — and I'm pleased that the Commission could contribute such a healthy contingent to these proceedings. It's also a pleasure to be here with Bob Herz [FASB Chairman] and David Tweedie [IASB Chairman], with whom I have done so much work in recent years to promote the convergence of GAAP and International Financial Reporting Standards (IFRS) and to establish the foundation for a truly global set of high quality accounting standards.
I should begin by thanking Financial Executives International (FEI) for once again hosting this important event. FEI does an extraordinary amount of good work that benefits investors throughout America and around the world. And our markets need your work now more than ever to reinforce the highest standards of financial reporting and integrity.
This year's Conference on Current Financial Reporting Issues is taking place at a critical time. The issues you have been addressing at these annual conferences for more than a quarter century are not only central to the current crisis, but dealing with them is also vital for the economy to regain its footing in the months ahead. You understand how important it is that investors have full and accurate information — and that for markets to work, the data driving them has to be reliable and transparent. And you appreciate that companies need consistent and clear reporting standards that they faithfully apply.
When the first of these conferences was held 27 years ago, world trade was vitally important — but it has become far more important in the intervening decades. The world's economies are far more closely interconnected and interdependent than they were in 1981. In that year, the value of all imports into the United States from the rest of the world, combined with the value of all exports from the U.S. to other countries, was less than $500 billion. Last year, that combined number topped $3 trillion. That's an increase of over 500%.
And not just trade in goods and services, but cross-border securities trading and investing has grown just as dramatically since the 1980s. Americans' holdings of foreign securities at the end of last year totaled over $6.5 trillion. At the same time, foreign private holdings of U.S. securities totaled over $6 trillion — and that doesn't count Treasury securities. To put this in perspective, U.S. ownership of foreign securities and U.S. securities owned by foreigners add up to almost the entire GDP of the United States last year.
What this means in practical terms is that markets in Bangkok are being affected by investment decisions made in Boise. Swings in the Dow may be related to trades originating in Dubai, or Dublin, or Dakar. The most recent and visible proof of this interdependence, of course, is the financial crisis that has swept the world’s economies.
We now know that while the trigger for the events of recent months was the meltdown of the U.S. mortgage market, what is underway is not simply an American contagion. The evidence is indisputable that the deeper roots of the crisis were entwined in scores of economies around the world. There was a real estate bubble not only in the U.S. but also in nations throughout Europe and the rest of the world — from Ireland, to Spain, to the Baltics and even India. Spain alone built more houses in the last 10 years than Britain, France, and Germany combined.
Earlier this year, the International Monetary Fund published its world economic outlook. The IMF compared housing prices in the U.S. and 16 other industrialized countries, and compared prevailing prices to their estimate of fundamental values. They found that at the end of last year, residential real estate in the U.S. was inflated about 10% above its fundamental worth. But that paled in comparison to the gap in other countries. In Ireland, for example, the IMF reports the bubble was 30% above fundamental value at the end of 2007. The United States ranked roughly in the middle of the global pack, in terms of the size of our real estate bubble.
The same was true in banking. The lending and fiscal decisions made by some European institutions have made U.S. banks look downright conservative. In Iceland, for example, the three largest banks guaranteed up to a 5.4% rate of return for foreign investors. Little surprise, perhaps, that all three are now in receivership. At the onset of the current crisis, the leverage ratio of European banking institutions far exceeded the 12-1 average ratio of American commercial banks. And while gross leverage is not a very precise indicator of institutional risk, it is interesting, for comparison sake alone, to note that in Britain, the average leverage ratio of 24-1 was twice that of the United States. In France it was 28-1. Swiss banks were levered at 29-1, and in Germany, the average leverage was 52-1. Short-term debt among banks in Belgium, Switzerland, Iceland and Britain was actually larger than their entire national GDP.
That leverage was used in many cases to purchase the same asset classes that American financial institutions held, and the results were just as predictable. From the collapse of the Dutch-Belgian lender Fortis, to the Icelandic banks, to the last-minute rescues of Hypo Real Estate and Royal Bank of Scotland, to the decisions across Europe to insure deposits and make massive capital injections into banks, we have seen that there are no longer any economic islands. And it is precisely because none of us is sitting untouched by the currents and waves of global finance that we must recognize, as Benjamin Franklin astutely put it, that “we must all hang together, or most assuredly we shall all hang separately.”
For several years the SEC has known that our mission of protecting American investors can't be accomplished without close cooperation with our regulatory counterparts in North America and overseas. Our strategy has been to focus our efforts on three areas — coordination on international standards, cooperation in law enforcement, and real-time consultation on regulatory actions as events unfold.
The first of these — coordination on international standards — has already been the subject of some discussion at this Conference. The events of recent months have only underscored the importance of an international language of financial disclosure and transparency. Achieving this would significantly improve investor confidence in global capital markets. Investors could more easily compare issuers' disclosures, regardless of what country or jurisdiction they came from. They could more easily weigh investment opportunities in their own countries against competing opportunities in other markets. And a single set of high-quality standards would be a great boon to emerging markets, because investors could have greater confidence in the transparency of financial reporting.
The fact that today, two-thirds of American investors own securities of foreign companies means that the SEC has an abiding interest in ensuring that IFRS are truly high quality and consistently applied across jurisdictions. Whatever the future of IFRS for U.S. issuers, retail and institutional investors alike in our country are relying upon IFRS today.
Since March of last year, the SEC has held three roundtables on IFRS. The most recent one was late last month, when we looked at the relative performance of IFRS and U.S. GAAP during the subprime crisis. A year ago, the Commission issued a concept release on allowing U.S. issuers to prepare financial statements using IFRS. After a great deal of public comment and analysis, that in turn led, just last week, to the Commission's publication of a proposed Roadmap that could lead to the use of IFRS by U.S. issuers beginning in 2014, if the Commission believes it to be in the public interest and consistent with the protection of investors.
The proposed Roadmap is cautious and careful. It is a multi-year plan that lays out both the basis for considering the use of IFRS by U.S. issuers, and several important milestones that would have to be achieved first.
In order for IFRS to fulfill the promise it holds to be a uniter of the world's capital markets and a powerful tool for investors everywhere, there are a handful of principles that are critical to its success. Every one of us here today needs to see to it that these principles are applied.
First, the standards must be crafted in the interest of investors. That has to be their overarching purpose. We all know that a business's financial reports are relied upon by many other people for many purposes. Financial statements are used by the managers of the business as an important tool in making decisions. They are relied upon by many outside parties, such as commercial lenders who extend credit to the business. And of course financial reports are important to analysts of all kinds for purposes that go far beyond investing, as for example when economists use them as a basis for reporting about an industry's size and other aggregate statistics. But above all, a public company's financial reports represent a direct communication between the company and its investors. And from the investor's standpoint, accounting standards should promote both clarity and comparability.
In these respects, both the IASB and the IASC Foundation, its governing body, are working hard to ensure that investors' interests remain the primary concern in the continuing development of IFRS. This is particularly important today, as the IASB reviews its standards in light of the experience of the recent market turmoil. This focus on the investor's interest in global comparability is also evident in the aggressive support of the IASC Foundation for eXtensible Business Reporting Language — a priority shared by FEI. In the same way that IFRS might someday soon make financial statements understandable to investors anywhere on earth, the 30 different spoken languages that will someday soon be embedded in XBRL data tags attached to public company financial statements could let any investor read an IFRS financial statement from any country in his or her own native language.
The second principle for the success of IFRS is that the standard setting process must be transparent. That is essential not only to maintain investor confidence, but to ensure the integrity and quality of the standards. Open due process is necessary so that investors and the many others who participate in our capital markets can be assured that their views will be thoughtfully considered.
Third, the standard setter must be independent. That means independent from special pleaders, from the political process, from favored industries or industry players, and from national or regional biases. An independent standard setter is best positioned to develop unbiased standards that foster investor confidence and transparency.
The standard setter must also be accountable. This means ensuring that IFRS actually meet the needs of investors and other stakeholders, and that they are updated in a timely way.
And finally, it is vitally important that all of the stakeholders themselves participate in the standard setting process in order to ensure the continued success of IFRS. The current dialogue among securities regulators over IFRS development is an essential ingredient in its steady progress.
As IFRS gain acceptance around the world, the ultimate question remains: Will IFRS function as the single set of high-quality, global accounting standards? At least, when it comes to satisfying investors' concerns, there is no question of the attractiveness of the promise of a truly global accounting standard. The only real question is not whether this is good for investors, but how quickly both the accounting standards and the process by which they are established and developed can be globally recognized as world-class.
Beyond the important work being done on IFRS, the SEC has a central mission as a law-enforcement agency. As the credit crisis has unfolded throughout the world during 2008, the SEC has been working closely with our international enforcement counterparts to investigate the causes of this year's unprecedented market volatility, as well as those who may have unlawfully promoted it or profited by it, and the extent to which market manipulation might have contributed to it.
The scale of our international enforcement cooperation has been massive. Over the last year, the SEC made 556 requests of foreign regulators for assistance with SEC investigations. That's more than one a day on average. Many of these investigations are linked to possible wrongdoing in the subprime area. At this moment, the SEC is working on 12 open subprime investigations with our foreign regulatory counterparts. Some of these are large scale and complex investigations that require cooperative access to each other's files. In some of these matters there is also an ongoing criminal investigation, both here in the United States and abroad. At the same time, many international enforcement agencies are making requests of the SEC for assistance with their own investigations. In the past year the SEC received 454 requests from foreign regulators for this kind of law enforcement help. And we have been eager to provide it.
All of these cooperative international efforts have led to tangible and impressive results. Let me give you just a few examples.
Recently, the High Court of Justice in London ordered an asset freeze in the UK against a UK citizen who was a defendant in a pending SEC action in Boston. Our action alleges significant ongoing fraud in a hedge fund operation. The UK Financial Services Authority provided us with intelligence that was instrumental in the SEC's obtaining a Freezing Order in the UK courts on our own behalf.
In another recent case, our Enforcement staff worked with the Swiss Federal Banking Commission to develop intelligence about suspicious insider trading that helped the SEC win a temporary restraining order in U.S. District Court. We also used that information through the U.S. Department of Justice to ask the Swiss federal criminal authorities to freeze accounts in Switzerland. Already, millions of dollars have been frozen in that action, and the figure may still be rising.
In yet another cross-border case that is still underway, the SEC is tracking down a securities fraud scheme masterminded by a Spanish national living in Barcelona, who operated through a number of offshore companies based in such far-flung jurisdictions as Panama, Dominica, Belize, and the British Virgin Islands. Once we determined that the money from the fraud had been wired to Andorra, we were able to obtain an asset freeze with the help of the Andorran authorities. And both the United States and Andorra are now pursuing criminal actions as well.
In recent years, the SEC has entered into enforcement MOUs with many international authorities. More recently we have placed emphasis on an enhanced enforcement MOU that goes well beyond what is reflected in these existing agreements, or in the IOSCO Multilateral Memorandum of Understanding.
This new kind of agreement for broader assistance would extend to the sharing of accounting information, including audit work papers. Securities regulators would agree to share telephone and Internet service provider records. The agreement would also cover the confidential exchange of credit card records, travel records, employment information, and corporate records. Beyond that, regulators would assist one another in obtaining records of electronic and telephonic communication, as well as testimony, responses to questions, and statements from witnesses.
We have recently executed an enhanced enforcement MOU between the SEC and the Australian Securities & Investments Commission (ASIC) that provides for precisely these types of assistance. The SEC and ASIC are also committed to seeking asset freezes on each other's behalf, and to assisting with the restitution of funds to injured investors. We hope that this enhanced level of enforcement cooperation will serve as a model for other jurisdictions, and possibly set a new international standard.
Finally, in the SEC’s third area of international focus — real-time consultation in the context of unfolding events — our deepened relationships with scores of regulators around the world have paid significant dividends. We've been able to work exceptionally closely with our overseas counterparts to ensure that our responses and policy prescriptions have been both well coordinated and mutually well understood.
In our global economy, a step taken by one market regulator may have only a limited impact if it is not supported by its international peers. And it's also true that, given the ease with which capital flows across borders, regulations in one market can have significant unintended consequences in other markets. That has made these consultations of absolutely vital importance.
We have also been careful to appreciate the difference between international coordination and international regulation. My experience over the last three years in the leadership of the International Organization of Securities Commissions has convinced me of both the value of close international consultation and the inadvisability of IOSCO's becoming a global securities regulator. Securities regulations can and should be converged to a far higher degree than we have already attained. But it is unrealistic to think we could or should make them identical, because of differences in national laws, economic conditions, and objectives. These differences are healthy and normal. It is entirely reasonable for a nation to view its responsibility to its own citizens and markets as paramount. The Securities and Exchange Commission is responsible for the protection of American investors, and it will never compromise that mission. Nor should any other national regulator. One of the reasons for the remarkable success of IOSCO is that it understands this very well.
There is yet another reason that global consultative bodies should not aspire to become global regulators. As we have learned to our misfortune time and again, international agencies often are forced to regulate to the lowest common denominator. Of necessity, they must yield to the average rather than the highest standards of their members in order to achieve consensus. Worse, the tensions that every national regulator is bound to reconcile — of factions and stakeholders, not to mention of parliaments, legislatures, and executive authorities — are multiplied a hundredfold in international bodies. These are concerns that should be considered seriously before assigning the function of global systemic risk “czar” or any similar responsibility to an international body.
While the United States has some obvious and correctable regulatory gaps, we have also set the highest regulatory standards for our markets of any country on earth. We should use the power of those markets to help raise world standards — which is the aim of our nascent mutual recognition initiative. The flight to quality that is currently underway is but the latest reminder that in the long run, countries can only win the global competition for capital by protecting investors with stronger, more transparent markets.
It is not mere coincidence that the world's largest capital market, by far, also has the world's highest standards.
No organization more than FEI has better understood the imperatives of the global capital markets. Your work in recent months, both as an organization, and individually in your many professional capacities, has made it crystal clear that you understand the dangers of taking a parochial view of the markets and our economies. And your leadership in working toward clear and consistent international standards for financial reporting has made you valuable allies of the SEC. As we continue our important work of protecting investors, maintaining fair and orderly markets, and promoting capital formation, we are proud to have you as our partners.