Speech by SEC Staff:
Remarks to the Practising Law Institute’s SEC Speaks Series

by

Conrad Hewitt

Chief Accountant
U.S. Securities and Exchange Commission

Washington, D.C.
Febrary 9, 2007

Good afternoon everyone. I know that you have already had a full day of input from several Commissioners and members of the SEC staff. However, I want to cover some new subjects with you today. As you are probably aware, the accounting and auditing professions are going through tremendous changes and face many challenges. The changes and challenges take on many forms, such as complexity, legal liability, PCAOB inspections, international convergence, moving from rules to principles, increasing use of fair value measurements, SOX 404 requirements, concentration of public accounting firms into the Big 4, XBRL, and US competitiveness in the world's capital markets.

As usual, 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 I express today are my own and do not necessarily reflect the views of the Commission, Commissioners or other staff of the Commission.

I'm sure you're getting concerned at this point that I am going to attempt to cover all of these and keep you here until midnight - rest assured, I will not. But I do want to bring you up to speed on our office's efforts in a number of these areas. Specifically, I will focus on the following key initiatives:

-Complexity

-XBRL

-Auditor liability

-International Convergence

-AS 5 and management guidance

Before I begin to talk about complexity, I do want to let you know that I have a new Deputy Chief Accountant to head the accounting branch of my office. I am pleased that Jim Kroeker, formerly a partner with Deloitte & Touche, joined us on Monday. Jim is here today, please take the opportunity to introduce yourself to him.

Now, let me begin with complexity.

When Chairman Cox interviewed me, he shared with me that one of his priorities was to do something with the complexity of the accounting and auditing standards.

I agreed with him 100% based upon my recent experience of serving on five boards of directors and chairman of the audit committee for each of those five boards.

In November 2006, I participated in the "Global Public Policy Symposium" held in Paris. The CEOs of the six largest accounting firms issued a paper entitled "Global Capital Markets and the Global Economy." The paper included the following thoughts on complexity:

1. "Today's rules can produce financial statements that virtually no one understands."
2. "Complex rules must be resisted and withdrawn."

There is almost universal support among companies, auditors, and investors that we must do something about the complexity of our standards. I will begin in the next two months formulating a framework for this needed and important project.

I want to work with the FASB, AICPA, PCAOB, FEI and others to begin a project to eliminate unnecessary complexity in financial reporting. The more I am involved with our accounting standards, the more I am convinced that we need to simplify standards that are overly complex, and difficult for issuers to implement without extensive outside assistance. While we often focus on the problems that complexity causes for preparers and auditors, we must also remember that complexity imposes significant costs on investors by making it difficult, if not impossible, for the average investor to understand the amounts and disclosures in a company's financial statements.

One alternative is for an independent body headed by a prominent person to begin this project. This independent body would conduct a study that focuses on what created the need, if any, for our complex financial reporting systems and on solutions to the underlying issues that create those complexities.

I believe that some lawyers prefer the precise legal requirements that come from rule-based standards. Unfortunately, this can lead to an emphasis on form over substance. I think that accountants should focus more on the economic substance of a transaction rather than its form - to prevent situations such as ENRON. Maybe we should get back to the "P" in GAAP, instead of using rules for our standards. There is no "R" in GAAP.

I would like to spend a few minutes on XBRL - extensible business reporting language. Probably all of your clients will be involved in and will be using XBRL in their filings at some point in the future.

When interviewing with Chairman Cox, I asked him what his vision and priorities were. He had the same vision and priorities that I had except for XBRL. I told him that I did not know much about XBRL, but I liked the concept and have always been a strong believer in using technology. Since I have been involved in XBRL, I am very excited about its potential.

Presently, we have over 40 companies that have made over 100 filings on a volunteer basis with us using XBRL. The results have been excellent with little cost involved.

Let me explain what XBRL is. I know that you are all familiar with the application of bar codes.

Well, XBRL is comprised of many "taxonomies." What is a taxonomy? It defines, identifies and tags a piece of data. What kind of data? The current project is working on identifying the data contained in financial statements, footnotes, management discussion and analysis, management's report, and the accountants' reports. It is an ambitious, but important project for the future of business reporting. The AICPA, PCAOB, FEI, banking regulators and the International Accounting Foundation are all involved in this project.

What is the timing of the taxonomy project currently underway? A date for finishing the project has been set for late summer of this year. Then, testing of the system has to be accomplished.

Who will benefit from XBRL? Obviously, it will benefit regulators, financial analysts, rating agencies, companies, consumers, and most importantly investors. XBRL will be a tremendous way to deliver and compare information using a common-denominator-taxonomy. It will be the electronic communicator of business and financial information. XBRL will permit a "user-friendly" basis for the use of interactive data. Other benefits of XBRL include: (1) greater transparency of financial data; (2) more reliable financial data; (3) faster financial reporting; (4) fewer errors in our filings; (5) more cost effective reporting; and (6) greater understanding and reliance on data by investors. We will continue looking for new ways to exploit the potential of XBRL technology. In fact, we are currently considering ways to enhance the retrievability of the wealth of information that will be disclosed in proxy statements pursuant to the Commission's new executive compensation disclosure rules.

While XBRL is a new topic, auditor liability has been a concern for some time and continues to be a concern, especially since the demise of Arthur Andersen.

When I was in practice for 33 years, it seemed that accounting firms were the final target because the company did not have the resources left to be sued. In other words, the big accounting firms were the deep pocket. I saw a number of meritless lawsuits, which were expensive to defend and took a lot of management time.

Today the issue does not appear to be the number of meritless lawsuits that are filed, but the fact that potential claims against the major accounting firms can be so large that a judgment in any one case might force a firm into bankruptcy and result in further consolidation of the audit profession with fewer firms.

Now, there is no easy solution to auditor's liability. However, five European countries have a liability cap - Germany, Austria, Belgium, Greece and Slovenia. Britain is introducing the concept of "proportionate liability."

Earlier this month, the European Commission issued a policy paper stating that the big audit firms should be given legal protection against damage claims.

According to the European Commission paper, there are four possible ways to improve protection for the audit industry:

1. Impose a fixed monetary cap for auditor liability.
2. Introduce a cap based on market capitalization of the audited company.
3. Introduce a cap based on a multiple of the audit fees charged by the auditor to the client.
4. Introduce the principle of "proportionate liability" thus limiting the auditor's damages to those caused by their own mistakes and not their clients.

Probably the European Union will adopt one or a combination of these four solutions.

In summary, in my opinion, the profession in the United States should consider ways to foster the vitality of, and competition within, the profession while ensuring that investors' interests are protected. One option may be for the profession to advance a reasonable proposal to Congress to limit the amount of liability to which an audit firm is exposed for violations of the federal securities laws, in ways similar to those being explored in the European Union. Such liability caps have been used in the US when excessive liability threatens the vitality of other professions.

Having mentioned the European Union, it seems appropriate to say a few words about the projects related to the international convergence of accounting standards. My predecessor, Don Nicolaisen, laid out what is commonly referred to as the "Roadmap." The Roadmap sets forth the milestones toward eliminating the need for the US GAAP reconciliation requirement for foreign issuers who list in the US capital markets and who prepare financial statements using International Financial Reporting Standards ("IFRS") by 2009 or possibly sooner.

Currently, the FASB and the International Accounting Standards Board ("IASB") are working on a number of joint projects. These projects include critical items such as business combinations, consolidations, revenue recognition, and a conceptual framework. I am pleased with the progress being made so far.

This Roadmap is very important because it considers the efficiency of the US capital markets and the effects on investors, and has the potential to lower costs to issuers relative to the current reconciliation requirements. The SEC staff is reviewing the foreign registrants' IFRS financial statements received to date, which will help us better understand the differences and application of IFRS. You can expect that promoting the convergence of accounting standards around the world will be a continued focus of our efforts.

Moving on to Section 404, let me begin with the PCAOB's proposed new auditing standard on internal control over financial reporting, which was proposed for public comment on December 19th by the PCAOB. The proposed standard, which is expected to be issued as AS No. 5, is a new standard that will replace AS No. 2. AS 5 should result in significant changes in auditing internal controls, including a more integrated approach to both the internal control and financial statement audits. AS 5 emphasizes a top-down, risk-based approach that is designed to focus auditors on the controls that are most likely to prevent or detect material errors in the financial statements. The proposal eliminates the requirement for the auditor to evaluate management's assessment process - which we understand has been at least partly the reason that many companies designed their evaluations perhaps as much to satisfy their auditors as to meeting the assessment objectives.

We are very interested in the cost versus benefit relationship for smaller companies (4500 public companies with a public float under $75 million - micro-cap). In that regard, the proposed standard includes a separate section on scaling the audit for smaller and less complex companies. This separate section will serve as the foundation for additional guidance that the PCAOB, with the assistance of a task force of auditors of smaller companies, is in the process of developing. We will be especially interested in reviewing the feedback that the PCAOB receives on this part of the proposal.

This is important because Section 404 auditing costs are very regressive for smaller companies - some say at least five times as costly relative to larger companies. If you attend the accounting workshop later today, my deputy, Zoe-Vonna Palmrose, will cover AS5 in more detail.

Moving on to our proposal of management guidance for 404 - the Commission exposed the proposed guidance for comment on December 20, 2006. The comment period ends on February 26, coincidentally the same date as the PCAOB's proposal. We hope that this guidance will be helpful to those companies that will be conducting their first assessments of internal controls in 2007.

Further, we hope that companies that have already completed assessments over the past three years will use this guidance to review what they have been doing with an eye towards making their processes more efficient and effective. We want companies to focus their efforts and resources on those controls that are most likely to prevent or detect material misstatement to the financial statements. As with the PCAOB comment letters, we are looking forward to your comment letters on our proposal. I strongly urge you to comment on both of the PCAOB proposed standards and our management guidance proposal. We will listen to you and use your suggestions.

I have covered five topics here with you today.

1. Complexity
2. XBRL
3. Legal Liability
4. International Convergence
5. AS 5 and Management Guidance

Thank you for your attention and time. It has been a pleasure to be here. Please enjoy the rest of the conference.

http://www.sec.gov/news/speech/2007/spch020907cwh.htm