Remarks at the 32nd Annual SEC and Financial Reporting Institute Conference
Chief Accountant, Office of the Chief Accountant
U.S. Securities and Exchange Commission
May 30, 2013
As a matter of policy, the Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author’s views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the SEC Staff.
I would like to thank Randy (Beatty) for the kind invitation to speak at this conference. I think this conference provides an excellent chance for members of the SEC staff to leave the East Coast and interact with registrants from this part of the country. I do need to take a moment to provide the staff disclaimer for not only myself, but for all of the SEC staff who are speaking at this program today.
With my time this morning, I thought I would focus on the following topics:
- Why the U.S. needs a strong IASB and what are we doing about it
- Definition of a successful implementation of an accounting standard
- PCAOB accomplishments
- Internal Controls and the new COSO Framework
This does not mean I am limited to these topics. In fact, there is the Q&A session later in the day if you have specific questions you would like me to address. Although if the question starts with a FASB codification reference, you might want to consider taking advantage of our pre-filing consultation process to have your question answered.
Why the U.S. needs a strong IASB and what are we doing about it
I thought I would spend several minutes talking about why the United States has a vested interest in making sure that the International Accounting Standards Board (IASB) continues to function as a strong and independent accounting standard setter. However, it is important to highlight that these remarks are not intended to forecast what the Office of the Chief Accountant (OCA) might recommend to the Commission or what the Commission might be thinking in terms of next steps for IFRS for domestic issuers. The consideration of IFRS for domestic issuers is a complex issue. There also are several recent and future anticipated changes at the Commission level. So despite that “double disclaimer,” the focus of my remarks is why IFRS matters in today’s U.S. capital markets and not trying to predict or give an indication of what might happen next.
Put simply, the reason that IFRS matters to the U.S. is that the U.S. is heavily invested in companies that prepare their financial statements using IFRS. Let me illustrate through an example. Recently, I was reviewing my financial holdings, and I was once again struck by the fact that in one of my mutual fund holdings I pay foreign taxes every time I receive a dividend from the fund. This time, I decided to look at the underlying holdings of the fund. When I reviewed the holdings of the fund, I found that the holdings were dominated by companies that prepare their financial statements using IFRS. I imagine your personal experience is very similar.
But let me start with a quick history lesson on the use of IFRS in the U.S. In 2007, the Commission removed the requirement for foreign private issuers to reconcile financial statements prepared using IFRS to U.S. GAAP. Outside the U.S., the removal of the reconciliation requirement was hailed as a significant event in the context of the development of IFRS. In the adopting release, the Commission noted,
“IFRS as issued by the IASB and U.S. GAAP are both sets of high-quality accounting standards that are similar to one another in many respects, and the convergence efforts to date have progressed in eliminating many differences.”
The fact that the Commission required IFRS as issued by the IASB without any sort of ongoing endorsement mechanism or suitability test is notable. Most other large jurisdictions utilize some sort of endorsement mechanism to ensure suitability. To me, this represents a significant amount of confidence placed in the IASB as an institution, and its governance, to produce high-quality accounting standards.
So what do we know about the current use of IFRS in the United States? In the context of foreign private issuers, there are over 450 filers who use IFRS without reconciliation to U.S. GAAP. The market capitalization of these filers is in the multiple of trillions of U.S. dollars. The Division of Corporation Finance has an Assistant Director (AD) group dedicated to large financial institutions. Of the banks included in this AD group, approximately forty percent of them file financial statements prepared using IFRS. Finally, there are undeterminable amounts of capital invested through mutual funds and direct financial investments in jurisdictions that require or permit use of IFRS.
There are a number of things the Commission, the Commission’s staff, and others are doing to protect investors who are investing in entities with financial statements utilizing IFRS within our markets, but there are also network benefits to the global financial reporting community at large. These efforts take many forms: from working to help ensure that the IASB’s standards are the highest quality standards possible, to helping ensure that IFRS is consistently applied. In fact the staff’s involvement in the process has increased over the past several years. Let me explain several of these, and these are all steps beyond the important convergence work between the Financial Accounting Standards Board (FASB) and the IASB, which I will speak about later.
First, from a governance perspective, the Chair of the SEC is a member of the IFRS Monitoring Board. In this role, the Chair endeavors to fulfill the mission of the Monitoring Board, which in part includes,
“To monitor and reinforce the public interest oversight function of the IFRS Foundation, while preserving the independence of the IASB.”
Second, the staff works to monitor the development of IFRS through observing the IASB standard setting process. This observation manifests itself in many different ways, including following all of the IASB’s standard setting projects and providing feedback on the projects where appropriate. The staff also participates in working groups of the IASB; for example, an SEC staff member is a member of the IASB’s Consultative Group - Methodology for Fieldwork & Effect Analyses.
Third, the staff works to promote consistent application of IFRS on a global basis. As will be discussed later in the conference, the Division of Corporation Finance reviews the filings of foreign private issuers and issues comment letters on the filings. The comment letters and responses are made public following the same process the Division uses for domestic registrants. Global accounting firms and other regulators look to these comments to see areas where the staff is focusing their efforts.
In OCA, we consider pre-filing accounting consultation requests on IFRS matters from registrants and their auditors. This is an opportunity for us to interact not only with the registrants and their auditors, but also with our regulatory counterparts. The staff is increasing its interactions with our regulatory counterparts in a number of different ways—both formal and informal—including outreach to our counterparts on specific registrant issues and discussions on broad policy matters.
Fourth, it is not just the SEC staff that is working to improve the quality of IFRS. As Russ (Golden) will discuss in a couple minutes, the FASB is a member of the IASB’s new Accounting Standards Advisory Forum, or ASAF. The objective of ASAF is to provide an advisory forum where members can constructively contribute towards the achievement of the IASB’s goal of developing globally accepted high-quality accounting standards.
Successful implementation of an accounting standard
Turning to the FASB and its work with the IASB, over the next 18 months the two Boards will complete some of the most fundamental projects on their respective agendas, and by that I mean the high priority convergence projects. As I mentioned in a speech last December, successful implementation of these standards is of paramount importance. From my perspective, it is never too early to start focusing on making sure we take the steps necessary to make implementation of these standards as successful as possible.
Some may ask, however, how do I define a successful implementation of a standard? I think a successful implementation is when the standards are applied consistently among registrants and their auditors to the benefit of investors. To the extent there are judgments applied, the standards should result in those judgments being clearly disclosed to investors so they can factor that into their analysis.
At the SEC, the staff already is beginning to think about how we are going to manage implementation of these standards. This includes some critical fundamentals, such as training for SEC staff across the Commission. It also includes thinking about what sort of outreach we plan to have with preparers and auditors to identify any issues during the implementation period. I am encouraged that for the revenue standard, the FASB will be using an implementation group to address issues as they arise. I am sure we will talk about this group in the convergence panel in a later session. The creation of an implementation group can greatly reduce the likelihood that we will need to consider supplemental guidance during the implementation period.
One final quick thought on this subject. One thing that I believe will be helpful is for the FASB and the IASB to provide long implementation periods on these projects given the amount of effort that will be required to implement them successfully.
One of OCA’s roles is to assist the Commission in discharging its oversight responsibilities over the Public Company Accounting Oversight Board (PCAOB). Over the last decade, the PCAOB has had many accomplishments, and I believe there is no question that investors have benefited overall. While it is good to reflect on past accomplishments, it is equally, if not more, important to reflect on what we have learned from the last decade and think about what we can improve for the future.
So I’ll start by acknowledging the significant progress the PCAOB has made in reaching new cooperative agreements and developing stronger relationships with a growing number of non-U.S. regulators. This progress has enabled the PCAOB to conduct inspections of audits in increasing numbers of jurisdictions around the world. The PCAOB, under the SEC’s oversight, has achieved significant successes in the past couple of years in advancing international coordination in its inspections program. The PCAOB has now conducted inspections in 40 foreign jurisdictions. New arrangements are now in place with a number of countries, including France, Germany, Finland and Spain, to perform on-site inspections of auditors located in those countries.
I believe a strong, global inspection program is a critical component to the Board’s overall evaluation of auditor performance. It also provides important information to inform the PCAOB about the current level of audit quality and where improvement is needed. Inspection results should also inform the PCAOB’s standard setting activities. My Professional Practice Group Deputy, Brian Croteau, often refers to this as “the audit performance feedback loop.”
Global coordination in audit oversight continues to be important. Audit regulators around the world are advancing a new paradigm for working together. The U.S. plays an important role through the PCAOB’s leadership roles in the International Forum of Independent Audit Regulators (IFIAR). In April, PCAOB Board Member Lewis H. Ferguson took office as Chair of IFIAR. Through IFIAR, individual regulators can get a better window on the global landscape of audit practice and financial reporting.
But let’s not forget about the important role of auditors themselves. As Commissioner Walter [who is speaking later today] has mentioned many times, auditors have the important role as gatekeepers to the public securities markets. With far-reaching audit policy considerations taking place around the world, auditors need to stay focused on investor needs for reliable financial reporting. I strongly believe that auditors should stay focused on their important role in auditing historical financial statements, rather than trying to predict the future, as I have heard some suggest from time to time.
Internal Controls and the New COSO Framework
Increased attention on internal control over financial reporting was an important element of the Sarbanes-Oxley Act of 2002, and I believe it continues to be important now and will remain so in the future. In December, the Board issued a report on its observations from 2010 inspections of annually-inspected firms regarding deficiencies in audits of internal control over financial reporting (ICFR). This report includes information about the nature and frequency of deficiencies in firms’ audits of ICFR detected during the PCAOB’s 2010 inspections of eight large annually-inspected firms. It would not surprise me if some of the audit deficiencies around ICFR may also be indicative of deficiencies in management’s own internal controls.
It is important to remember that management and auditors both have responsibilities with respect to ICFR, regardless of whether the company is exempt from the requirement to have an auditor’s attestation on ICFR under Section 404(b) of the Sarbanes-Oxley Act. It also is important to recognize that the benefits to reliable financial reporting are dependent upon the ongoing commitment by management to maintaining effective ICFR.
There is new guidance that management may find helpful in implementing and evaluating its internal control. The Committee of Sponsoring Organizations of the Treadway Commission (COSO) recently released its updated internal control framework, which is intended to provide more comprehensive and relevant conceptual and practical guidance by focusing on 17 principles to help management focus on important aspects of the components of internal control.
I understand that COSO intends to supersede their 1992 Framework as of December 15, 2014, and we expect there will be questions about whether the SEC will provide management with any transition or implementation guidance to change from the existing framework to the new framework. COSO has publicly stated its belief that “users should transition their applications and related documentation to the updated Framework as soon as is feasible under their particular circumstances” and that “the key concepts and principles embedded in the original framework are fundamentally sound and broadly accepted in the marketplace, and accordingly, continued use of the 1992 framework during the transition period (May 14, 2013 to December 15, 2014) is acceptable.” COSO further explained “the COSO Board’s goal in updating the original Framework has been to reflect changes in the business and operating environments, to formalize more explicitly the principles embedded in the original framework that facilitate development of effective internal control and assessment of its effectiveness, and to increase the ease of use when applied to an entity objective.”
SEC staff plans to monitor the transition for issuers using the 1992 framework to evaluate whether and if any staff or Commission actions become necessary or appropriate at some point in the future. However, at this time, I’ll simply refer users of the COSO framework to the statements COSO has made about their new framework and their thoughts about transition.
Once again, I would like to thank you for the invitation to speak to you today at this conference. Enoy the rest of the conference.