AMERICAN ACCOUNTING ASSOCIATION 1997 Annual Meeting Dallas, Texas August 17, 1997 INTERNATIONAL HARMONIZATION OF ACCOUNTING STANDARDS: Perspectives from the Securities and Exchange Commission Remarks by Michael H. Sutton Chief Accountant Office of the Chief Accountant United States Securities and Exchange Commission Washington, DC __________________________________ The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of Mr. Sutton and do not necessarily reflect the views of the Commission or the other members of the staff of the Commission. INTERNATIONAL HARMONIZATION OF ACCOUNTING STANDARDS: Perspectives from the Securities and Exchange Commission INTRODUCTION I am pleased to be here today to share my perspectives on international harmonization of accounting standards, a topic that the Commission has been deeply involved in for several years. Looking back over the last decade, we have seen significant political and economic change worldwide -- change that has created major new demands for capital and, therefore, new investment opportunities. At the same time, investors have broadened their horizons beyond national borders. As these trends continue, the call for more harmony in capital market financial reporting and disclosure can be expected to continue. But as we attempt to answer that call, we must keep in focus the investor protection mission that has been the foundation of the Commission’s public mandate. My remarks today will focus on three points: * The Commission’s role in setting US accounting standards, * The Commission’s involvement in international standard setting to date, and * My thoughts about the future. THE COMMISSION'S ROLE IN SETTING US ACCOUNTING STANDARDS The Securities and Exchange Commission was established in the wake of the greatest financial disaster this country has ever experienced. The stock market crash in October 1929 and its aftermath were times when substantial investments became worthless in a matter of hours and days and when investors and the public lost confidence in our securities markets. In response, the Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934, which granted to the Commission the authority to promulgate accounting principles for SEC registrants and to prescribe the form and content of financial statements filed with the Commission.1 Those laws, and related rules and regulations subsequently adopted by the Commission, mandate initial and continuing disclosures that companies must make if their securities are sold to or traded by the US investing public. The goals of this disclosure system are to prevent misleading or incomplete financial reporting and to facilitate informed decisions by the investing public. Practically since its inception, the Commission has looked to the private sector for leadership in establishing and improving accounting principles to be used by public companies.2 The Commission’s willingness to look to the private sector, however, has been with the understanding that the Commission may exercise its statutory authority and supplement, override, or otherwise amend private sector accounting standards. Still, the traditional standard-setting role that the Commission has chosen has been one of oversight of the private sector processes. Since 1973, the Commission has looked to the Financial Accounting Standards Board (FASB) as the private sector body whose standards are considered to have substantial authoritative support. This partnership with the private sector can be thought of as an endorsement of a process for establishing accounting standards under the oversight of the Commission. The current efforts to develop a core set of international accounting standards, however, is focused on a specific standard setting goal, which creates a different role and responsibility for the staff. Let’s take a brief look at the history of the Commission’s involvement in the international standard setting process. INVOLVEMENT IN INTERNATIONAL STANDARD SETTING TO DATE For the past several years, the International Organization of Securities Commissions (IOSCO), of which the SEC is a member, has been working with the International Accounting Standards Committee (IASC) on a project to develop a core set of standards that might become a framework for financial reporting in cross- border securities offerings.3 In 1994, IOSCO reviewed the existing IASC standards and identified 14 completed standards that, with certain reservations, would be considered acceptable for inclusion in a core set of standards. IOSCO also identified those standards that need to be improved before acceptance can be considered, including areas in which there are “essential issues” -- issues deemed critical to the success of the project by some countries. In July 1995, IOSCO and the IASC agreed on a core standards work plan,4 and in April 1996, the IASC announced an intention to try to complete that plan by March 1998.5 In April 1996, the Commission released a statement in support of the efforts of IOSCO and the IASC. That statement indicated that, if the IASC successfully completes the agreed-upon work plan, the Commission will consider accepting the core standards in securities offerings by foreign issuers in the US.6 The statement identified three key elements that, in the Commission’s view, are necessary for the standards to gain that acceptance. Those three elements are as follows: 1. The standards should include a core set of accounting pronouncements that constitute a comprehensive, generally accepted basis of accounting. 2. The standards must be of “high quality” -- they must result in comparability and transparency, and they must provide for full disclosure. Investors must be able to meaningfully analyze performance across time periods and among companies. 3. The standards must be rigorously interpreted and applied. If accounting standards are to satisfy the objective of having similar transactions and events accounted for in similar ways -- whenever and wherever they are encountered - - auditors and regulators around the world must insist on rigorous interpretation and application of those standards. Otherwise, the comparability and transparency that is the objective of common standards will be eroded. Because the Commission will need to assess the acceptability of the core standards for use in US markets, the staff has been active in following the IASC project. For example, staff members have attended IASC steering committee and Board meetings as IOSCO observers, and the staff has provided detailed written comments on proposed standards. This participation does not mean that the Commission is obliged to accept the resulting product -- rather, it reflects a commitment to support this effort with timely input. The acceptability of the core standards will be decided after the project is completed, with appropriate public input, based on the substance of those standards and the degree to which they meet the three key elements identified by the Commission. 7 THOUGHTS ABOUT THE FUTURE Having described the Commission’s role in setting US accounting standards, and its involvement in international standard setting to date, I turn to some thoughts about the future. Recently, a financial officer at a major German industrial company commented on his perception of the Commission’s registration and listing requirements. He said, “People at the SEC are like civil servants .... They have their rules, and when something does not comply exactly, then it’s unacceptable. You may be very healthy financially, but they can’t judge that unless it is set out in a particular way.”8 This statement suggests that, at times, the Commission may be perceived to be slavishly bound to a fixed set of rules and resistant to other points of view. It also suggests, I fear, that there may be some misunderstanding about our perspectives and our motives. Yes, we do seek rigorous interpretation and application of accounting and disclosure rules. But, we do so because we believe that comparable and transparent reporting -- reporting that allows individual and institutional investors to make their own evaluation of a company’s financial health -- is important to the protection of US investors. In the final analysis, I believe that even those who view US standards as being too rigid or too demanding -- or as imposing too many reporting obligations on management -- recognize that there is a reason why US accounting and disclosure has evolved differently from that in other countries -- and a reason for its attractiveness to us as capital market regulators. The US system has been shaped to meet the needs of investors and capital markets, and this orientation differentiates it from systems developed in many other countries. In US capital markets, investor protection is achieved not through merit regulation -- allowing only “healthy” companies to trade their securities -- but by market regulation -- ensuring that all who seek access to US markets provide full and fair disclosure of the risks to investors. Underlying that approach is a strong belief that the success of US capital markets is due in large measure to the high quality of the accounting and disclosure standards used by US public companies. Those standards give investors confidence in the credibility of financial reporting in the US -- a cornerstone of our capital markets that we cannot afford to compromise. The US accounting and disclosure system supports -- indeed, makes possible -- the deep and far-reaching tradition of participation by individual investors in our capital markets. The willingness of individual households to invest in stocks and bonds creates a much larger pool of investor funds in the US than anywhere else in the world. As the process of harmonizing financial reporting continues, we should not allow a desire to increase the access of foreign registrants to US markets to take priority over the interests of US investors. For the Commission to consider reducing or eliminating our reconciliation requirements, I believe that it must conclude that any alternative standards that might be accepted deliver to the capital markets what US standards convey -- credible information that is grounded in transparent, comparable financial reporting. We also should keep in mind that completion of the IASC core standards project is not the sole yardstick for measuring the success or failure of international harmonization. Cooperative efforts by a number of entities, including national standard setters as well as the IASC, are producing tangible benefits. Financial reporting around the world is becoming more oriented to the needs of investors -- placing those needs ahead of the policy objectives of tax authorities or the interests of private creditors -- and each time that happens, the potential for harmonization increases. Thus, while the IASC’s efforts to complete a core set of accounting standards is an important goal, it is not the end game. As we contemplate the next steps, let me suggest some guideposts that I believe are important for longer-term success: * The process for harmonizing accounting standards should, itself, be based on a harmonious relationship among the national and international standards setters. The goal should not be to replace or eliminate the need for national standard setters. * The national standard setters should be fully engaged in and lead those efforts -- they should be the primary players in the standard-setting process. * The process must be independent and shielded from unwarranted pressure from constituents and special interests. * The sovereignty of national standard setters and regulators must be respected. It is likely that the need for national tailoring of accounting and disclosure rules will continue, and national capital markets must be free to decide the needs of their investors. CONCLUSION In closing, let me emphasize my belief that the US can make a tremendous contribution to the development of international accounting standards. We have, on the whole, the most successful private sector standard-setting process in the world. Through the FASB, as well as the efforts of the Commission, we have the opportunity to help shape the development of accounting standards internationally and to help assure that investors around the world receive the financial information they need. Bibliography Accounting Series Release No. 4. 1938. Securities and Exchange Commission(April 4). Accounting Series Release No. 150. 1973. Securities and Exchange Commission (December 20). Andrews, Edmund L. 1996. “Making Stock Buyers of Wary Germans.” The New York Times (October 17) D1, D6. Bayless, R., J. Cochrane, T. Harris, J. Leisenring, J. McLaughlin, and J.P. Wirtz. 1996. “International Access to US Capital Markets.” Accounting Horizons (March) 75 - 94. Cochran, Thomas N. 1996. “Germany’s Biggest Deal.” Barron’s (November 4) 20. Lowenstein, Louis. 1996. “Financial Transparency and Corporate Governance: You Manage What You Measure.” Columbia Law Review (June) 1335 - 1362. Meek, Vicky, “Big is Beautiful.” Accountancy (June 1997), pp. 30 - 31. Schweikart, J.A., S.J. Gray, and S.B. Salter. 1996. “An Interview with Sir Bryan Carsberg.” Accounting Horizons (March) 110 - 117. Securities Act of 1933, 15 US Code Section 77a, et seq. Securities Exchange Act of 1934, 15 US Code Section 78a, et seq. Securities and Exchange Commission Regulation S-X. 17 Code of Federal Regulations Section 210. Securities and Exchange Commission Rule 144A. 17 Code of Federal Regulations Section 230. 144A. Sutton, Michael H., 1997. “Financial Reporting in US Capital Markets: International Dimensions.” Accounting Horizons (June) 96 - 102. _______________________________ 1 See, for example, Sections 7, 19(a) and Items (25), (26), and (27) of Schedule A of the Securities Act of 1933, and Sections 12, 13(b)(1) and 17(e)(2) of the Securities Exchange Act of 1934. The Commission also was given the authority to define accounting terms. See Section 19(a) of the Securities Act of 1933, and Section 3(b) of the Securities Exchange Act of 1934. 2 Early Commission reliance on the private sector for setting accounting standards is found in Accounting Series Release No. 4. 3 See Bayless, et. al. (1996) for more information about IOSCO and the IASC. That paper also discusses the various ways in which foreign registrants are currently meeting the US reporting requirements (pp. 78 - 81). One role of the Commission in international financial reporting is to provide guidance to foreign companies that want to offer securities in the US. 4 A discussion of the IASC work plan can be found in Schweikart, et. al. (1996). 5 The announcement is contained in a press release by the IASC titled, “IASC Accelerates Work Programme,” dated April 3, 1996. 6 The Commission statement appeared as a press release titled, “SEC Statement Regarding International Accounting Standards,” dated April 11, 1996. 7 While the Commission is unwilling to accept financial statements prepared using IASC standards at this time, it has allowed companies to use certain elements of IASC standards without reconciliation to US GAAP (Bayless, et al. 1996. 83). 8 “Big Is Beautiful,” Vicky Meek. Accountancy, June 1997, 30 - 31, quoting Bernd-Joachim Menn, Bayer.