Speech by SEC Commissioner:
"The SEC's Evolving Regulatory Role in an Increasingly Integrated World Economy"
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
May 15, 2006
Madame La Ministre Legarde, Monsieur Rameix, Monsieur Dorison, Monsieur Nahum, Monsieur Hoffman, Mesdames et Monsieurs, c'est un très grand honneur et plaisir pour moi d'être parmi vous aujourd'hui. Je souhaiterais remercier plus particulièrement France-Amériques, IMA France, Académie des Sciences Comptables, et l'ambassade des États Unis pour l'organisation de cet événement. Je devrais préciser tout d'abord, ainsi que j'y suis obligé, que les avis que j'exprime aujourd'hui sont les miens, et qu'ils ne reflètent pas nécessairement ceux de la Securities and Exchange Commission ou de mes Co-commissionnaires.
C'est un grand plaisir pour moi de me retrouver en Europe, et en particulier a Paris. J'ai vécu dans cette merveilleuse ville pendant deux ans et demi. Hier, j'ai eu le plaisir de retrouver quelques vieux amis et même mon ancien bailleur - il est peut-être étonnant que certains locataires parisiens puissent encore avoir des bonnes relations avec leurs propriétaires, même après une absence de seize ans. Le fait d'être à Paris me donne donc toujours l'impression de retourner à un endroit qui est particulièrement proche de mon cur.
La question de la coopération Américano-Européenne est une de mes préoccupations particulières. Ce que je souhaite faire aujourd'hui est de discuter avec vous du climat commercial et législatif aux Etats-Unis et des relations commerciales transatlantiques. J'aimerais également discuter de certains domaines de coopération transatlantique qui seront, a mon avis, d'une importance particulière dans les années à venir.
Mesdames et monsieurs, dans cet esprit de coopération transatlantique, je pense que le moment est venu d'arrêter le massacre d'une langue qui vous est chère, et de poursuivre en anglais, ou plutôt en américain.1
One of the most important relationships and perhaps the most important relationship for the United States is our political, military, and commercial interaction with Europe. Our deep cultural and historical ties are bolstered by what truly is an amazing partnership in terms of mutual investment, trade, and commerce. The world has never before seen such an enormous, interdependent relationship. As we discuss various issues, we never should lose sight of these ties, which are so important to creating jobs and wealth for all parts of society, improving our technology, and bettering our quality of life in terms of medical breakthroughs, longer life spans, safer products, and a healthier environment. This breathtaking innovation and wondrous product diversity responding to the dreams, desires, and wishes of billions of people has been created mostly by the amazing, even chaotic engine of private efforts that Dr. Ludwig von Mises described so well in his book Human Action. The depth, transparency, and liquidity of the international capital markets have played a crucial part in these successes.
And what is the state of our trans-Atlantic relationship today? I would dispute anyone who would say that it is not fundamentally healthy. We are the biggest investors in each others' economies, and we are each other's foremost trading partners. We have the largest cultural exchanges of any continents on earth, through tourism, education, and employment. Of course, as with any relationship be it marriage or friendship or whatever there are inevitable strains and disagreements. But, we must never forget the disaster that befell the Western World in the years following the First World War, when old ways of thinking, economic nationalism, and basic misunderstanding of economics led to economic disaster, financial ruin, and war.
And what is the state of the American economy in May 2006? As my father always used to tell me, don't believe everything that you read in the newspapers. Although many press reports would have you believe otherwise, America's economy is strong and growing. The Dow Jones Industrials is currently at around 11,400, nearing the all-time peak it reached on January 14, 2000. The gross domestic product expanded at a solid 3.5 percent pace last year. In the first quarter of this year, the American economy grew at an impressive rate of 4.8% the fastest of any industrialized nation. Worker productivity has been growing at the highest rate in decades, and that is leading to higher wages for our workers. Our nation has added jobs for 31 months in a row a total of more than 5.1 million new jobs created since May of 2003, more than two million of them in just the past year. Unemployment has fallen to 4.7 percent, lower than the average for any decade since the 1950s. More Americans than ever own their own homes and, in a vote of confidence for our financial markets, fully half of all U.S. households and one-in-three individuals own equities.2 Today, nearly 57 million U.S. households own stocks directly or through mutual funds. From a foreign investor's perspective, our taxes are low for an industrialized country, our rules regarding acquisitions of interests in American companies are relatively investor-friendly and flexible, our laws do not place restrictions on repatriation of investment, and large parts of our country are free from the distorting influences of trades unions.
So why, you may ask, is a commissioner of the US Securities and Exchange Commission concerned with these macroeconomic statistics? Although many people regard the SEC as a prosecutorial agency, we are more than that. To be sure, we are charged by Congress with policing the securities markets on behalf of investors for fraud, deception, and manipulation. That is certainly historically the most important aspect of our mission. But, we are also charged by Congress with facilitating capital formation and maintaining fair, orderly, and efficient markets.
Our mission to facilitate capital formation extends not just to companies headquartered in the United States, but to those from outside the country as well. That is why the SEC must be ever concerned about maintaining the position of the United States as an attractive place for investors from any country to invest their capital. We must be careful to balance the costs versus benefits of our regulations we must maintain the integrity of our markets so that investors have confidence that they will be treated fairly, but we also must not price those very investors out of our markets through burdensome regulations.
One of my great concerns is that some of our regulations may be discouraging foreign investment. A week ago today, the British firm Cable & Wireless issued a press release announcing that it is requiring all U.S. stockholders with fewer than 100,000 shares to dispose of their holdings. This decision implemented an amendment to the company's Articles of Association that the shareholders approved in December by 97.8% of the votes cast.3
In fact, it is not a voluntary provision. If American shareholders do not sell, then the company will sell the shares on their behalf! Apparently, the company will then be able to terminate the registration of its shares with the Securities and Exchange Commission because it will have fewer than 300 U.S. shareholders. The Financial Times quite rightly described this move as an "innovative" tactic but one that is clearly not in the interest of American shareholders.4
This action follows on reports of other companies which have elected not to register their shares in the United States. Is there, in fact, a rising trend for companies not to register their shares in the United States? If so, it is a trend that is certainly not welcome from my perspective. According to the Wall Street Journal, up until the year 2000 nine out of every 10 dollars raised by foreign companies through new stock listings were done in New York. But, by 2005, the numbers had reversed so that the ratio now is nine out of every 10 dollars are raised outside of America.5
Of course, since many of the companies that would have been listing in New York are likely going to European exchanges, I realize that many in this audience might applaud the problems that we Americans have, apparently, largely brought on ourselves. I am, however, concerned because it is becoming increasingly plausible that this trend reflects, if not actual, then at least perceived inefficiencies in the American regulatory system. As we all know, perceptions can be every bit as important as reality, especially in the financial markets. Because of our mandate from Congress to protect investors and encourage capital formation, it is important that the SEC balance the costs of regulations with the anticipated benefits and rigorously examine whether those benefits can be achieved through the method chosen.
Certainly, though, the reasons why companies may choose not to list in the United States are multifaceted. Some reasons may reflect conditions that the SEC has the means to address. For example, increased costs and risks associated with the implementation of the Sarbanes-Oxley legislation passed in 2002 are a significant contributor to both the reality and perception of increased costs. This is something the Securities and Exchange Commission has some ability to address.
In an ideal world neither the Sarbanes-Oxley Act nor the implementing rules should dissuade a foreign company from considering a U.S. listing. Foreign listings not only benefit U.S. investors in the form of greater investment choices and diversification, but also provide foreign issuers with access to the U.S. capital markets and greater potential for making acquisitions in the U.S. However, in the real world, the decisions of foreign issuers are clearly influenced by the real and perceived costs of Sarbanes-Oxley compliance.
For example, there is much discussion within and outside the SEC regarding ways in which individual provisions of the Sarbanes-Oxley Act may be imposing a greater cost than was anticipated, or than may be justified by the benefits imparted to investors. One provision in particular is the implementation of Section 404 of the Act, which requires management to complete an annual internal control report and requires the company's auditor to attest to, and report on, management's assessment. This is perhaps the most controversial provision of the Sarbanes-Oxley Act.
Just this past week, the SEC and the Public Company Accounting Oversight Board held an all-day session with more than 50 witnesses to discuss Section 404. We heard much about both the benefits and the costs of the implementation of this provision. I can assure you that in the coming months, the SEC and the PCAOB will be considering steps to cut the costs while maintaining the benefits of Section 404. I continue to believe that, if we can find a cost-effective way for Section 404 to achieve its objectives, it could be one of the most valuable parts of the Act.
The emphasis on good controls over financial reporting is laudable. Section 404 focuses on the integrity of financial information and seeks to give shareholders some insight into the credibility of financial statements. The principle is that investors might step up their scrutiny of financial statements of a company that has been found to have "material weaknesses" in the internal controls around the processes that produce its financial statements.
It is indisputable that everyone greatly underestimated the costs involved in the 404 process. When the SEC first released its implementation rules for 404, we estimated that the aggregate costs would be about $1.24 billion or $94,000 per public company. Actual costs incurred during year one for 404 compliance, according to surveys, were some TWENTY times higher than estimated costs. In the SEC's defense, we made this estimate before the Public Company Accounting Oversight Board released its 300-page Auditing Standard No. 2 to govern the 404 process.
It is widely acknowledged that under AS2, corporate management and auditing firms have been much too conservative in exercising their judgment. We hear too many stories of how people seem to be driven by the impulse to document virtually every process in an effort to appear to be thorough and to avoid being second-guessed by regulators and litigators. The PCAOB itself acknowledged this in a report it issued in November 2005 on the implementation of AS2. The PCAOB found that there were problems with its implementation, including a tendency to employ a bottom-up approach, which resulted in the expenditure of "more time and effort than was necessary to complete the audit."
The good news for foreign private issuers is that the SEC has recognized the difficulties that Section 404 may pose, particularly in combination with migration to the new International Financial Reporting Standards. Last March we extended the Section 404 compliance date for foreign private issuers for another year such that foreign issuers now need to comply with Section 404 for their first fiscal year ending on or after July 15, 2006. We also extended the compliance deadline for smaller public companies, including smaller foreign private issuers. These companies will have to comply with the Section 404 requirements for their first fiscal year ending on or after July 15, 2007. This is consistent with other accommodations that we have made for non-U.S. issuers since we first started to implement Sarbanes-Oxley.
We will continue to work on a more rational approach to implementing Section 404. Last Wednesday's conference has given us the impetus, the facts, and the determination to make effective changes to improve the operation of this rule. I have made no secret of what I view as the need to re-examine the PCAOB's Audit Standard 2. We will do this, and I promise you that it will be changed for the better.
If we are able to address the Section 404 problems and evaluate whether there are other areas where the cost of complying with Sarbanes-Oxley can be reduced without diminishing investor protection, we will begin to address the concerns expressed by international as well as domestic issuers.
Deregistration is another area where foreign issuers have expressed concern, and the SEC has reacted to the concerns of the marketplace. Currently, the process for a foreign issuer to deregister in the United States can be uncertain, complicated, and costly. In an effort to simplify the process, in December of last year the SEC published for comment a proposed rule concerning a foreign private issuer's termination of its reporting requirements.
The idea is to make the process for deregistration clearer and less cumbersome. While the immediate prospect of losing registrants may be unattractive, a longer-term view suggests that non-U.S. companies are more likely to register with us if they know that they are not making an eternal commitment. We must recognize that conditions change for individual registrants. We should allow for as much flexibility as possible, without sacrificing the expectations of and fairness to American equity investors.
Under current rules, a foreign issuer may exit the registration and reporting regime only if fewer than 300 record holders of the issuer's securities are U.S. residents. Under this rule, a foreign issuer unless it takes the rather drastic approach of Cable & Wireless may find it difficult to terminate its Exchange Act registration and reporting obligations even if there is relatively little investor interest in the United States. The proposed rule would let foreign issuers terminate, and not merely suspend, their reporting requirements as long as they meet certain conditions.
I understand that there may be some debate over the actual number of foreign issuers that would be eligible to deregister under the proposed rules. The Financial Times recently called the SEC's prediction that a quarter of foreign companies could exit under the proposed rule "totally detached from reality."6 I have heard numbers ranging anywhere from 5% to 26% of issuers. Some have said that these numbers may not be high enough. But, please bear in mind that our underlying premise is to allow companies to shed their registration obligations if there is relatively little interest by US investors in the domestic market.
Another topic I would like to address is the effort to achieve convergence between U.S. GAAP and International Financial Reporting Standards. Done correctly, convergence holds out the promise of allowing investors to compare more reliably the results of competing firms based in different regions and thereby facilitates the global flow of capital. This, in turn, will ease the task of raising funds for all companies regardless of where they are situated.
I am optimistic that the United States and the European Union are on track to realize significant improvements in both GAAP and IFRS as a result of the convergence effort. The Financial Accounting Standards Board and the International Accounting Standards Board have been working attentively in the effort to eliminate differences between U.S. GAAP and IFRS consistent with the Norwalk Agreement. As you know, that agreement, issued in October 2002, commits both the FASB and the IASB to work toward convergence where the result will be an improvement to either GAAP or IFRS, or to both. I have heard several comments that the level of cooperation between the two accounting boards is excellent, and some hold it up as a model for European and American cooperation more generally. Certainly, the process is progressing at a rate far faster than I would have anticipated when the process began.
That being said, I do not believe 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 may be an impractical objective. 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. Achieving evenness in the application of the new standards may be as important as narrowing the differences between the formal accounting systems.
Last April, our Chairman and chief accountant set out a so-called "roadmap" by which they anticipated a 2007-2009 timeframe of mutual recognition of accounting standards. I was happy to support this plan and personally remain confident that the SEC will meet this timetable. Certainly, none of the changes in personnel at the SEC during the past year has caused any rethinking of this timetable or how important we perceive its successful completion. I am confident that the need for reconciliation will disappear as all of us gain experience with IFRS in practice, which can be done within this timeframe.
There is great interest in the United States in how European companies manage the transition to International Financial Reporting Standards. We recognize, of course, that this is a difficult process. I applaud the effort towards greater transparency and understand that European companies are concerned about continuing to bear the costs of reconciliation to U.S. GAAP in addition to switching to IFRS. I expect that, consistent with the roadmap and the ongoing encouraging progress on convergence, the day will come soon when companies conforming to IFRS will be able to raise capital in the United States without reconciling their results to GAAP. Certainly, the level of comfort with IFRS that such a development would reflect will be a great boon to investors.
However, I am concerned by suggestions from some that Europeans should begin to require U.S. companies to reconcile their U.S. GAAP financial statements to IFRS. This runs against the direction that we are taking in the United States and undermines our efforts towards mutual recognition. Some may assert that this is a useful bargaining chip to ensure that we Americans will recognize IFRS. But, I believe that it is counter-productive, ignores historical precedent and market practice, and diverts attention and energy from solving the real challenges before us. Because of the size of the US markets historically, US GAAP was the benchmark against which others compared their financials, not just because of SEC rules, but also because of investor demand. Our process recognizes the growth of the international marketplace and that IFRS has the potential as it is implemented to be a coherent, consistent standard. IFRS will stand or fall on its own merits. Our collective efforts on both sides of the Atlantic should be focused on making sure that it succeeds.
With your assistance, we can work to address some of your concerns about recent regulatory reforms in the U.S. We can also work to shape future regulatory initiatives so that they fulfill their intended function of protecting investors without imposing unnecessary burdens in the U.S. and abroad. I am confident that international cooperation in these regulatory matters will benefit all of us in the long run.
For us to succeed, I ask that you actively participate in our debate. Lawmakers and regulators cannot be faulted for missing important issues if they were not brought to their attention when the laws and regulations were being considered. The SEC, for example, is legally bound to take comments into account and explain why we accept or reject them. We take this obligation seriously and look to investors, regulators, and corporations outside the U.S. for information and insights about unique challenges that our rules may pose for them. By representing your own interests effectively, you help us to protect investors in U.S. markets be they US citizens or others and maximize the efficiency of the global economy.
Mesdames et monsieurs, je vous remercie donc pour votre attention, et pour votre patience. Je serais heureux de répondre à vos questions, que vous pouvez me poser en français. Si cela ne vous pose pas de problème, permettez-moi d'y répondre en anglais.
It is a pleasure to be in Europe once again, particularly back here in Paris. As a lawyer, I was resident in this beautiful city for 2½ years. Yesterday, I was fortunate to be able to get together with some old friends following my arrival and even with my former landlord yes, there are some tenants in Paris who have good relations with their landlords, even after 16 years! So, being in Paris always makes me feel as though I am coming home to a place that is very close to my heart.
The topic of European and American cooperation is one that is very important to me. What I would like to do today is to discuss with you the current business and regulatory climate in the United States and the atmosphere in trans-Atlantic business relations. I should also like to address with you some of the areas in which trans-Atlantic coordination is going to be, in my view, particularly important in the years to come.
In that spirit of transatlantic cooperation, I think the time has come to stop the massacre of a language which is dear to you, and for me to continue in English, or rather in American.