Speech by SEC Commissioner:
Remarks Before the Association Française des Entreprises Privées
Commissioner Roel C. Campos
U.S. Securities and Exchange Commission
March 8, 2007
Good morning. To start, I'd like to thank Bertrand Collomb and AFEP for their kind invitation to join you here. Alexandre Tessier has also been most helpful. Obviously, it is my hope that I can provide some insight into some of the latest thinking at the SEC. In any event, before I begin, I must remind you that the comments I make today are my own and do not reflect the opinions of the staff or the other Commissioners of the Securities and Exchange Commission.
Despite some relatively recent foolishness by the U.S. Congress when it decreed that "French fries" should be known as "freedom fries," France and the United States share a long history of seeing eye-to-eye on issues of national importance and have long been good business partners. The sparring and public disagreements of our respective politicians over the years do not in any way remove the huge bond of friendship between our two peoples. I don't need to remind you that France came to the aid of the U.S. at our founding, by becoming our crucial ally in our successful Revolutionary War against Great Britain. Lafayette is an American hero alongside George Washington. Shortly thereafter, Pierre L'Enfant was named the designer of my adopted hometown of Washington, D.C., and his influence in that regard is still apparent in the city's open spaces, circles, symmetrical design and wide boulevards. I understand, however, that traffic is slightly worse nowadays. We even call our subway system the "Metro," although I don't think we can credit L'Enfant for that idea. Alexis De Tocqueville first described the nature of Americans as being different than Europeans - not bound by class or birth and more independent than anywhere in the world, and having broader ambitions.
In the 19th century, the Statue of Liberty was a gift of friendship from the people of France to the people of the United States and is a universal symbol of freedom and democracy. In the 20th century, France and the United States fought along side one another in the two world wars, as the Allies were successful in turning back the tide of fascism sweeping the world. One has only to visit the beaches in Normandy and the U.S. cemeteries there to understand how deeply our people have sacrificed to help the other.
Today, U.S. economic ties with France are extensive and mutually beneficial. Approximately $1 billion in commercial transactions takes place between the two countries every day of the year. France is the ninth largest merchandise trading partner for the United States and the sixth largest for trade in services. Moreover, foreign direct investment and the activities of foreign affiliates are also critical. Sales of U.S.-owned companies operating in France and French-owned companies operating in the United States outweigh trade transactions by a factor of five. France is technically the 5th largest foreign investor in the U.S., but is virtually tied with Japan, Germany and the Netherlands at the 2nd position.
It is my hope that as SEC commissioner, I can continue to work to remove unnecessary barriers to competition and to promote policies that provide for the efficient global spread of capital across the Atlantic Ocean and throughout the world. As I will mention in my remarks, the SEC has undertaken a number of recent actions that have and will greatly benefit French and international companies operating in the U.S., and we're committed to doing more in this regard.
II. Sarbanes-Oxley Section 404.
The first item that I'll address is the elephant in the room - the famous (or infamous) Section 404 of the Sarbanes-Oxley Act. I think this is the prototypical area in which the SEC has tried to show some flexibility - particularly with respect to foreign private issuers - without losing the importance of the rulemaking. In summary, the SEC and the PCAOB proposed a package of improvements in late December 2006 that I believe will essentially "fix" the implementation problems of Section 404 of the Sarbanes-Oxley Act.
It has been a long road getting here. Although the implementation costs and burdens of Section 404 have been much higher than originally anticipated, nearly three years of experience have made it clear that the benefits gained from improved internal controls over financial reporting are significant ones that we absolutely cannot afford to lose.
Thus, the challenge has been to modify and improve the overall Section 404 framework so that it remains robust and meaningful, yet cost-efficient and flexible enough to accommodate differences among companies. I believe that the combination of the SEC's proposed management guidance, together with the PCAOB's proposed new auditing standard on internal control (AS5), will likely meet this difficult challenge - dramatically reducing the inefficiencies and excessive costs of Section 404, while retaining all of the good.
First, by putting management - and management alone - in the "driver's seat," the SEC's proposed interpretive guidance should significantly reduce what several studies have identified as the largest proportion of Section 404 costs: management evaluation and documentation costs. Under this proposed interpretive guidance, management would be able to exercise a top-down, principles-based, proportionate approach that is risk-based, yet flexible enough to accommodate a tremendous range of companies - from the smallest of companies to the largest. By avoiding a "one-size fits all" approach, the SEC's proposed interpretive guidance and related rule changes encourage and, in fact, bless management efforts to design and conduct evaluations that are tailored to each company's size, complexity, business lines and circumstances. This new guidance promises to reduce much of the repetitive auditor work, and stabilize and lower the overall costs of Section 404 compliance.
Similarly, I believe that the PCAOB's proposal will, if adopted by the PCAOB and approved by the SEC, revamp the entire Section 404 attestation landscape by providing auditors with a clearly scalable auditing standard that focuses auditors on the highest-risk areas. Proposed AS5, together with a companion proposed auditing standard on considering and using the work of others, would eliminate many areas of duplicative, excessive, or unnecessary work. Among other improvements, it would remove the requirement for an auditor to evaluate management's evaluation process, permit auditors to utilize previous years' work to reduce testing, provide greater flexibility for auditors to rely on the work of others, and reduce the number of costly walkthroughs.
Investors and management have for some time recognized the huge benefits of Section 404 in producing more reliable financial information - enabling better decision-making for the creation of long term value. Accordingly, I am confident that investors will view Section 404 as the "platinum standard" and increasingly ask why other jurisdictions have not adopted all of the requirements of Section 404, including auditor attestation of internal controls. With the successful implementation of the joint package of guidance and standards to be issued by the SEC and the PCAOB, the costs of compliance with 404 will finally be rational to its benefits.
III. Foreign Private Issuer Deregistration.
Let me address another substantive area when the SEC has been open to constructive and intelligent criticism: foreign private issuer deregistration. Simply put, at long last, we're almost there. I've read a few of the comment letters with respect to reproposed rule, and I think we've received nearly universal acclaim for it. To quote from the letter of EALIC (the European Association for Listed Companies), of which AFEP I believe is a member: "We strongly support the Commission's revised rule proposal, which we believe addresses the deficiencies in the December 2005 proposal in a principled way."
This rulemaking is another example of what can happen when regulators take seriously their duty to protect investors, but at the same time ensuring that we promote capital formation and efficient markets. The fact of the matter is that, under the reproposed rule, the primary quantitative test would allow foreign private issuers to deregister if U.S. trading volume is less than 5% of the issuer's trading volume in its home market. Given this very low number, it's hard to say that we're abandoning our protection of U.S. investors. On the other hand, the rule reflects the reality of global regulation.
Now, I should point out that numerous commenters have suggested that we modify the denominator used for the trading volume test to include worldwide trading volume, and my initial thought is that this suggestion has merit. Of course, I don't want to prejudge anything before I have a full picture of the comments that we received, but I think we'll be in a position to move on this rule in the near future and to consider seriously using worldwide trading volume, which seems to have raised no serious objections from commenters.
I also think that the new rule will have a very positive effect on the ability of the U.S. markets to compete globally. In the short term, I imagine that we'll see deregistration by foreign issuers that do not have significant investor interest or much business in the U.S. On the other hand, the fact that we've modernized our exit regime should also make it more palatable for companies to seek capital here in the first place, for it will give them confidence that if there's little interest in their securities they won't be stuck here. Now, I don't believe that there will be a rush to the exits, for foreign issuers realize that there are many benefits to being in the U.S. To use just one example, the U.S. is the most "target rich" environment for acquisitions; nowhere else in the world are there more potential merger partners. Having securities already registered in the U.S. provides great flexibility in making acquisitions, and there is relatively little government regulation of mergers.
Another topic that I know is on your radar screen is the movement to one set of global accounting standards, and in particular, the "roadmap" outlined by former SEC Chief Accountant Don Nicolaisen back in 2005. In short, as you know, our foreign private issuers must currently reconcile their financial statements to U.S. GAAP. The roadmap, however, outlines the path toward eliminating the need for non-U.S. companies to reconcile to U.S. GAAP the financial statements they prepare pursuant to IFRS issued by the International Accounting Standards Board (IASB). This would obviously be extremely beneficial to foreign private issuers, and to reiterate my theme, this is another topic where the SEC is trying to eliminate barriers and to promote convergence of standards in the international arena. However, I want to caution that IFRS-GAAP reconciliation - and the elimination of the reconciliation - is still a work-in-process, not just for the U.S. but for others as well. So, this is a good news situation, with a caution.
The good news is that the SEC is absolutely committed to doing what we can to facilitate meeting the goals of roadmap. About a year ago and again just two days ago, our Chairman Chris Cox met with EU Internal Markets Commissioner Charlie McCreevy, and both affirmed their commitment to eliminating the need for reconciliation between IFRS and U.S. GAAP. Most recently, just two days ago, we hosted an IFRS roadmap roundtable, which was designed in large part to raise the profile of the roadmap in the U.S. So, the U.S. is serious about the roadmap and the timeline, and we're trying to make it work.
I must, however, focus on one curious aspect of the roadmap in practice, which is the lack of foreign private issuers filing audited financial statements with the SEC that either use or are compliant with IFRS in the manner in which it is issued by the IASB. We had expected to see approximately 300 or so companies file their 2005 financial statements prepared using IFRS. Instead, we received only about 40 filings - hardly a critical mass. This fact is perplexing, given that the early goal is - to quote the roadmap itself - "to see convergence in action." So, the question is: why did only 40 companies so file?
The answer is that there are likely a number of different reasons. I want to focus on just one of the reasons here, which is that, in many cases, financial statements prepared in accordance with home country adaptation of IFRS did not also contain a reference by both the company and its auditor that the financial statements also complied with IFRS in the form issued by the IASB. Indeed, the roadmap contemplated that we would see filings of financial statements prepared using IFRS as promulgated by the IASB. However, various jurisdictions have not accepted IFRS exactly as promulgated by the IASB, and have instead made various changes thereto. Consequently, we have seen filings containing financial statements based upon national jurisdictional adaptations of IFRS, such as a French adaptation, which, without the reference to IFRS as promulgated by the IASB, don't appear to be financial statements that fit under the one set of global accounting standards that we wrote about in the roadmap.
Now, we certainly understand why a jurisdiction may wish to adopt its own version of IFRS. However, one goal of the roadmap was to allow the elimination of the reconciliation requirement, and as a consequence, have only two versions of robust standards developed by independent standard setters in the U.S. capital markets - one U.S. GAAP and one IFRS - not thirty different versions. The question then occurs: how do we reach the "critical mass" - to use a term from the roadmap - of filers using IFRS as promulgated by the IASB? What will happen this year - year two of the roadmap? While the answer is not clear at this time, I think that serious discussion by issuers with their auditors may be necessary. I am hopeful that auditors could prepare opinions stating that the audited financial statements were prepared according to IFRS as promulgated by the IASB, and not solely the "Jurisdiction X IFRS." In any event, we need to get to the bottom of this issue, and see more companies filing audited financial statements in the manner contemplated by the roadmap.
Let me say a few words about the NYSE-Euronext merger. The SEC recently approved rule changes that will enable the businesses of NYSE Group and Euronext to be wholly-owned subsidiaries of a new publicly-traded holding company, NYSE Euronext. So, the SEC's role in the merger is pretty much complete, and I understand that the NYSE's exchange offer to Euronext shareholders is open until March 21, with a targeted closing date in early April.
It's important to note, as I have in the past, that the holding company structure will essentially allow both exchanges to operate in almost exactly the same manner as before. This is important because initially, the NYSE's overture was met with some resistance on this side of the Atlantic, due in large part to fears of U.S. regulatory creep. These fears have largely been allayed.
The proposed combination of the NYSE and Euronext will produce no exportation of U.S. regulation - Sarbanes-Oxley, for instance - to Europe. No European issuer will subject itself to U.S. regulation unless it voluntarily chooses to operate in America. Moreover, the European and American regulators have set up working groups to assure that the merger process goes smoothly and without surprises, and that no unintended regulatory creep occurs from the U.S. to Europe, or vice versa. Consequently, the Euronext supervisory board has recommended that shareholders tender their shares in the exchange offer.
Hopefully, now, we can view the merger much as we do other mergers. In particular, I know that both Euronext and NYSE Group believe the merger will create significant cost savings and revenue synergies, but will at the same time allow Euronext to preserve its successful federal business model.
That said, we cannot lose sight of the fact that cross-border exchange mergers are different than other mergers, and there may come a time when the goal is not to preserve each exchange as is. I believe that it is inevitable that a combined trans-Atlantic exchange organization will some day request the regulators on both sides of the Atlantic to cooperate in approving a common set of trading rules. Given the differences in the U.S. and Europe, achieving this will not be easy. I do believe that at some point in the future, some type of regulatory agreement will be negotiated between the SEC and European regulators, assuming of course that the current trends toward the convergence of standards continue. We'll just have to wait and see.
As a business proposition, it is clear to me that the combined NYSE/Euronext entity will seek in the future to be allowed to sell all securities listed on both Euronext and the NYSE in every place the entity operates. So, Euronext listings could be available to investors in New York, and New York listings could be available to investors in Paris and the other Euronext offices. This will challenge regulators as to what rules should apply.
VI. The Future of Cross-Border Regulation.
Let me shift topics here slightly. Instead of mentioning what the SEC has done to ease the regulatory burden on foreign issuers, I'll now turn to what the SEC might do. Specifically, I'm referring to ideas that have been termed "mutual recognition" and a "cooperative approach." These ideas were recently proposed in an article by Ethiopis Tafara, director of the SEC's Office of International Affairs, and Robert Peterson, an attorney in that same office,1 and also in a speech by Erik Sirri, the Director of our Division of Market Regulation.2
The General Approach. Generally speaking, under the mutual recognition approach, a foreign broker-dealer or exchange would apply for an exemption from SEC registration. The application would include certain information about the firm or exchange, as well as an agreement to submit to U.S. jurisdiction for the purposes of enforcement of U.S. anti-fraud laws. Further, the foreign entity would have to provide its U.S. customers with a prominent warning telling them that the firm and its products were not registered with the SEC. Following receipt of the application, the SEC would then begin a discussion with the foreign entity's home regulator and conduct a comparability assessment. The focus of the comparability assessment would be to determine whether the foreign jurisdiction's laws and regulations are similar enough to those in the U.S. to protect investors and the integrity of securities markets. The SEC would then negotiate and implement additional cross-border arrangements to make the bilateral oversight and enforcement programs work together, such as strengthened information-sharing agreements, regular regulatory discussions, and joint inspections. Finally, a key component of mutual recognition would be reciprocity - U.S. brokers and exchanges would have to be given similar access to investors in the foreign country.
Foreign Screens. Let me also discuss the cooperative approach, in connection with a specific application - that of foreign exchange screens in the U.S. For example, under our current rules, it can be difficult for individual U.S. investors to purchase securities of foreign companies directly. This is not to say it cannot be done, for an investor could make such a purchase, for example, through a mutual fund, from a broker-dealer located in the foreign country, or through a U.S. broker-dealer that has an affiliation with a broker-dealer that is registered with the foreign exchange. But what an individual investor cannot do is make a direct purchase from a U.S. broker-dealer who has a trading screen linked directly to the foreign exchange, which would be the most efficient way of purchasing such a security. However, if all of the conditions are met, a cooperative approach could allow a U.S. broker-dealer to join a foreign securities exchange, and then sell foreign securities that are not registered in the U.S. to retail U.S. investors via trading screens located in the U.S. This cooperative approach could potentially preserve investor protection while simultaneously promoting market competition.
These are interesting ideas, but many thorny issues must be resolved. For example, if a U.S. broker-dealer who has joined a foreign exchange is selling foreign securities that are not registered in the U.S., what does the SEC say to its domestic exchanges, like the NYSE and Nasdaq? They will surely wish to have the same privilege of selling the foreign unregistered securities. Also, if U.S. broker-dealers are allowed to sell foreign securities, then it would follow that U.S. exchange-listed securities would also be permitted to be sold through screens and exchanges outside the U.S. by foreign broker-dealers.
So, now, each national regulator has an interesting challenge. Since foreign securities registered in the home country would be accessible through screens, how would the regulator maintain its regulation and standards over the domestic issuers? If reporting standards are different in the foreign jurisdiction, the domestic issuer is going to say: why should we be subject to more demanding standards? For example, U.S. domestic issuers could argue that the application of quarterly reporting requirements, stringent executive compensation disclosure and even U.S. GAAP would be unfair to U.S. domestic issuers, given the exemptions now provided to foreign private issuers. So, the critical question becomes: can a regulator successfully impose more demanding standards on domestic issuers than it imposes on foreign issuers whose securities are freely sold through screens?
This is why many of us have urged a reasonable degree of convergence before embarking on any of the discussed approaches. Of course, the idea is that the U.S. would embrace these approaches only with jurisdictions that have a regulatory regime largely comparable to that of the U.S.
Still, because of these challenges, it may be appropriate to have an intermediate step in which only Qualified Institutional Buyers ("QIBs") would be permitted the privilege of purchasing through foreign screens and, only later, after full study, would the U.S. retail market be permitted to use foreign screens. That is one idea.
Let's also think for a minute about the foreign screen scenario with respect to potential litigation against the foreign issuers whose securities would be sold through screens in the U.S. Today, I suppose it is theoretically possible that a private individual in the U.S. who bought foreign securities through a broker-dealer in the U.S. could bring a lawsuit in a U.S. federal court (although unlikely). The federal court could assert jurisdiction over the issuer and allow a lawsuit for recovery of damages to go forward, requiring a defense of the lawsuit in the U.S. However, under the current system, an investor must generally take a number of significant steps to seek and buy foreign unregistered shares, which are typically not sold directly in the U.S.
Under the foreign screens example, however, the shares would be brought to the investor, giving a court more reason to assert jurisdiction. A strong notice from the broker-dealer to the investor of the lack of U.S. regulation could help, and the foreign screen approach would probably provide that issuers who do not otherwise promote and distribute their shares in the U.S. would continue to be subject only to home country regulation and home country laws. However, this might not be enough, and perhaps a waiver of rights to bring suit in the U.S. might also become the practice. This may also argue for only QIB participation in screens. Because of their sophistication, QIBs would have a hard time arguing in court that they did not knowingly take the risks of a foreign country law system.
So you see there is much to consider and resolve. I believe that we can come to satisfactory answers to these questions. We will of course consult extensively with our foreign regulator friends. I also want to caution that we are at the very preliminary stages of transforming these concepts into an actual framework. Much practical work and thinking must be done. At this stage, I think the concepts are promising. I support and endorse the SEC's study of whether they are practical and whether they support and enhance the SEC's mission. We are not yet, however, in a position to accept an application by a foreign regulator or exchange to begin overall discussions. But a proposed SEC rule to allow foreign screens in the U.S. and reciprocally to allow U.S. stocks to be sold through screens in foreign countries may very well be developed this year.
Hopefully, these concepts can improve U.S. investor access to foreign securities, by reducing the transaction costs and reducing overlapping regulation. At the same time, it is possible that they could encourage other jurisdictions to adopt high regulatory standards like the U.S., thereby minimizing regulatory arbitrage and the race to the bottom. It is also important that the SEC not lose sight of its investor protection mission. Whether these ideas will ultimately be workable remains to be seen, but they deserve serious study and consultation with other regulators, industry and investors.
In conclusion, let me reiterate that my theme that, despite some recent reports, the U.S. is still a great place in which to conduct offerings and to list securities. In fact, a recent study showed that there is a significant cross-listing premium associated with shares of non-U.S. companies cross listed on U.S. markets. Moreover, this cross-listing premium has persisted in each year from 1997 through 2005, and is not limited to only a few different countries. For example, and I quote: "The countries with the largest and most consistent exchange-listing premiums . . . include Canada, France, Germany, Israel, Japan, the Netherlands, and the U.K."
Moreover, the SEC is doing its part to lessen undue burden, especially for non-U.S. issuers. In addition to the accommodations that I mentioned previously - SOX 404, foreign deregistration and GAAP-IFRS - our rules have made numerous accommodations for foreign issuers. For example, our proxy rules and our new executive compensation disclosure rules do not apply to foreign private issuers, and the deadline for filing annual reports is 6 months after year end, as compared to 60-90 days for U.S. domestic issuers.
I understand that many of you think the U.S. can go further, and perhaps that's possible. But the primary mission of the SEC is to protect U.S. investors, and we need to be careful not to compromise that. Thank you again for the kind invitation to be here, and if you'd like, I can answer some of your questions.