Speech by SEC Staff:
Corporation Finance and the Foreign Private Issuer Community in 2007
John W. White
Director, Division of Corporation Finance
U.S. Securities and Exchange Commission
Practising Law Institute Conference
"Foreign Issuers & the U.S. Securities Laws 2007:
for the Changing Regulatory Environment"
New York, New York
May 2, 2007
Thank you, Nick. Good morning. Ethiopis Tafara, Paul Dudek and I from the SEC's staff are very pleased to be here today to talk with you about recent activities on the international front. As you may have noticed, we were generating news like crazy last week at the SEC, so this conference should be a success in reporting on recent developments: Tuesday it was the Commission issuing a press release on its planned next steps toward the goal of ending reconciliation for financial reporting in International Financial Reporting Standards ("IFRS"),1 Wednesday it was the signing of a protocol in the UK for sharing information on the application of IFRS,2 Thursday it was a regulatory cooperation agreement in Germany,3 and Friday it was a meeting in Belgium with the Committee of European Securities Regulators ("CESR") to take stock of the progress on the SEC-CESR joint work plan and to agree on the form of bilateral protocols for information sharing relating to application of IFRS.4 Much of this flurry of activity relates to a whirlwind trip that Chairman Cox and Ethiopis made through Europe last week, but of course IFRS is a topic that had been of particular focus by the Commission and its staff for some time now-I will have a few things to say on that front in a couple of minutes.
Before I talk any further, though, I should get the required disclaimer behind us. The U.S. Securities and Exchange Commission disclaims responsibility for any private statements of any SEC employee, including me. Thus, the views I'm going to express today are solely my own and do not necessarily reflect the views of the SEC or of any members of its staff other than myself.
It was just a little over three months ago when I last spoke, in Europe, at another PLI conference about matters of particular interest for the foreign issuer community.5 Although the topics of particular interest then and now may be the same in the broad sense, I am reminded of how much difference just a quarter makes. When I was in London in January, the Commission's foreign private issuer deregistration proposal was just that-a proposal. Now, of course, the rules have been adopted and will be effective next month. In preparing my remarks for London, I was told by others on the staff that it would be very meaningful if I, as the relatively new Director of Corporation Finance, could state expressly my support for the "roadmap" for ending the U.S. GAAP reconciliation requirement with regard to financial statements filed in IFRS-something I did with enthusiasm. But, I was just a staff member speaking with a disclaimer. Last week, one of those Commission press releases outlined significant steps that we can look forward to seeing in this area in the coming months, including a proposing release and a related concept release on the use of IFRS by U.S. domestic registrants. If I didn't support the work to end reconciliation, it seems clear that I would now be left behind. The Commission is moving forward.
The month after I came back from the London PLI program, I made another set of remarks in Dallas, Texas in which I outlined my sense of the Division's agenda and priorities for the upcoming year.6 What I would like to do today is to combine pieces of both those remarks and talk with you about what I see right now as being five of the current projects and priorities in Corporation Finance that may be of particular interest to the foreign private issuer and international communities. As you will note and might have predicted, many of the same topics run through each set of remarks, but they are developing fast and I am hopeful you will find the updates this morning useful.
1. Foreign Deregistration.
The Commission of course approved amended rules for foreign private issuer deregistration on March 21.7 The panel that follows me will be taking up the specifics of the new rules, so I will not get into those details now. But in short, foreign private issuers, regardless of size, will be allowed to terminate their Exchange Act registration and reporting obligations regarding a class of equity securities if the U.S. average daily trading volume for that security has been no greater than 5 percent of the security's average daily trading volume on a worldwide basis during a recent 12 month period. These rules will become effective on June 4-no one has used them yet obviously, but we understand some registrants are preparing to do so soon after they are effective. So far, based on the telephone calls and questions on the rulemaking that have been coming into the Division, it would seem that people have very few technical or mechanical questions about the new rules and how they will work.
I have made this point in numerous settings, but let me reiterate that our goal with the new deregistration rules is not to encourage foreign private issuers to withdraw from the U.S. Quite the opposite. I genuinely believe and hope that a more rational approach to deregistration-as well as an improved implementation of Section 404 of the Sarbanes-Oxley Act and a possible end to the U.S. GAAP reconciliation requirement in certain cases, both of which I will turn to in a moment-will improve the total picture as foreign companies contemplate entering the United States market in the future. I continue to believe that the new approach to deregistration will better serve the needs of both U.S. investors and non-U.S. issuers by providing a clear, consistent, easy-to-apply, and fair standard by which foreign registrants may completely withdraw from our capital markets and end their obligations to comply with our reporting rules. Meanwhile, the Commission and the staff are hard at work in other areas to improve reporting and the regulatory picture for those foreign issuers who are solidly anchored in the U.S. markets.
2. Section 404 and Internal Control Over Financial Reporting.
By completing our project to amend the rules for foreign deregistration on the timetable that we did, the staff and the Commission kept a commitment with which we had charged ourselves to make the rules available prior to the time the first reports under Section 404 of the Sarbanes-Oxley Act come due for foreign private issuers with calendar year-ends. As you know, Section 404 requires that companies provide two reports on their internal control over financial reporting: one, by management, of its assessment of those controls, and another by the company's independent auditors, attesting to management's assessment. Foreign private issuers with calendar year-ends that are large accelerated filers must provide both of those reports in their Annual Reports on Form 20 F that are due at the end of June. FPI's that are accelerated (but not large accelerated) issuers must provide only the management report with their upcoming 20 F's (although they may also provide the auditor report if they so choose). And finally, foreign private issuers that are non-accelerated filers (generally those with a market capitalization of less than $75 million) will not be required to provide either Section 404 report until next year (at which time, their first management assessment report will be due; audit reports won't be required until the following year). In keeping with its "next steps" that it announced a year ago for improving Section 404 implementation,8 the Commission and its staff have been working in earnest this past year on measures to improve the implementation conditions relating to both of the reports. So where do we stand on all of that one year later?
On December 13 of last year, the Commission voted to propose guidance, for the first time, for corporate management in performing their required assessments of their companies' internal control over financial reporting.9 Also in December, the Public Company Accounting Oversight Board ("PCAOB") proposed revisions to its internal control auditing standard. Any final standards adopted by the PCAOB must be approved by the Commission before they can become effective of course. Progress on both those proposals has been substantial, and just a month ago the Commission met publicly to discuss with its staff some remaining issues, many of which overlap the SEC's and the PCAOB's proposals (the webcast, along with a transcript, of that meeting is available on the Commission's website).10 We are now in the home stretch. As Chairman Chris Cox has informally stated, the Commission is slated to consider final adoption of its management guidance proposal on May 23 and the PCAOB's final vote on its revised auditing standards should follow shortly thereafter.
I hope that foreign private issuers will find any final management guidance to be helpful in providing registrants with a scalable, risk-based approach that can be used in performing their required evaluations. I anticipate that it also will be principles-based, which I think should provide a meaningful comfort zone for the international community. We have received over 200 comments on the proposal, of which 18 have come from foreign private issuers and foreign professional groups. Comments have generally been favorable on the Commission's proposal. While commenters have made various suggestions to revise and improve the proposed guidance, there seems fairly universal support for the project in general. I am not going to spend time today talking about the specifics of the proposal or about the comments we have received, but I thought I would touch on one point of interest unique to foreign registrants. There has been some confusion, and we received a number of comments, concerning how the reconciliation to U.S. GAAP should be handled when evaluating the effectiveness of internal controls.
The proposal has stated that foreign private issuers should scope their internal control evaluation efforts based on the financial statements as prepared in accordance with their home country generally accepted accounting principles (GAAP), rather than based on the U.S. GAAP reconciliation. At the same time, controls over the preparation of the reconciliation must be considered when performing the required evaluation so long as that reconciliation is a required part of the financial statements presented in the U.S. (as is currently the case with regard to all foreign private issuers who report in anything other than U.S. GAAP). I am myself comfortable that these are the right positions to take, although we have received some comments advocating different resolutions in this area. Obviously the Commission has not yet approved any final management guidance, but I expect these questions will be squarely addressed by the Commission or in related staff guidance later this month.
The Commission took one other step that changed meaningfully the Section 404 landscape for foreign private issuers-specifically for new entrants to the U.S. capital markets-when it adopted "transition relief" for newly public companies last December.11 Under these provisions, a newly public company (including a foreign private issuer listing in the U.S. for the first time) is not required to comply with the internal control reporting requirements of Section 404 until its second annual report required to be filed with the Commission. This accommodation should alleviate considerable costs and burdens for companies as they contemplate entering the U.S. capital markets, without reducing investor protections. Under this new model, companies that choose to enter the U.S. markets will not have to expend resources and time performing first-time evaluations of their controls under Section 404 until after they have registered with the Commission and entered the U.S. capital markets. This accommodation should also remove the risk that Section 404 may affect companies' timing decisions as they prepare to enter the U.S. markets. Section 404 was intended to enhance the reliability of financial reporting, not to be a deterrent to quality capital formation, and I believe the SEC's recent accommodation better aligns Section 404 with its purpose. At the same time, I personally feel that the rigor and scrutiny that various external parties (including underwriters, accountants and lawyers on all sides of the transaction) typically pay to newly public companies and their financial statements during that first year and initial listing period, even without Section 404 reporting, provide a meaningful and similar benefit to the investing public.
3. International Financial Reporting Standards ("IFRS") and A Possible End to Reconciliation.
That leads me then to what is probably the topic of most current interest today in the foreign issuer community: the Commission's recent announcement about its planned "next steps" with regard to International Financial Reporting Standards and possibly ending the requirement that companies that report in IFRS as published by the International Accounting Standards Board (IASB) reconcile those financial statements to U.S. GAAP. The Commission's press release last Tuesday (April 24) stated that it plans a proposal that will address eliminating the reconciliation requirements with respect to financial statements filed in IFRS beginning in 2009. The Commission also indicated that it plans to issue a Concept Release this summer (which I envision would be close in time to the proposing release) on the question of whether U.S. domestic issuers should likewise be able to choose to report using IFRS without reconciliation.
A little background here may be useful to make sure we all have the same stage set. As I am sure you know, today under the SEC's rules, foreign private issuers may file their financial statements in the U.S. using their home country GAAP or using IFRS. They may also use U.S. GAAP if they choose. If a foreign registrant reports in something other than U.S. GAAP, then it must provide certain information that is reconciled to U.S. GAAP in accordance with our rules, and in most cases provide all of the information called for under U.S. GAAP and Regulation S-X if that information is not otherwise required under home country GAAP or IFRS. I anticipate that the proposal that will be on the table will involve removing the reconciliation requirement for issuers who are reporting in IFRS as published by the IASB.
The Commission's next steps press release is itself a logical step after the Roundtable on IFRS that senior staff held back on March 6 and of the staff roadmap for ending reconciliation which was laid out in April 2005 by the SEC's then-Chief Accountant Don Nicolaisen. If you missed the Roundtable, I would encourage you to look at it in the Commission's webcast archives.12 Or review the transcript.13 There is also available on the website a speech that I gave in March here in New York summarizing what I heard at the Roundtable and providing some of my reactions.14 Finally, if you're unfamiliar with the roadmap itself, I would encourage you to read it.15 It too is available on the Commission's website.
A couple of points of clarification regarding the recent press release and the underlying questions. First, I do not think there was an intent to suggest that foreign private issuers will be forced to report in either U.S. GAAP or IFRS, and not other home country GAAPs as they can today. When the press release talks about issuers having a choice between IFRS or U.S. GAAP, it was not meant to imply that foreign private issuers would no longer be permitted to report in, and reconcile from, some other home country GAAP. At the same time, and acknowledging that the Commission has not spoken on this question yet, I personally would anticipate that it will remain the case that if a foreign private issuer does report in something other than U.S. GAAP or IFRS as published by the IASB, then a reconciliation requirement will persist.
I have made a point of deliberately referring to "IFRS as published by the IASB," or International Accounting Standards Board. As I stressed in London in January, and as various others on the staff have emphasized, the roadmap talks about ending reconciliation only with regard to IFRS as published by the IASB. Many companies may be reporting in IFRS as varied by different adopting jurisdictions. I do not anticipate that ending reconciliation for "jurisdictional adaptations" of IFRS will be recommended.
Jurisdictional adaptations of IFRS arise for various reasons and may have merit behind them. But I believe that for the goals of the roadmap to be achieved, we need one widely accepted, high quality set of global IFRS. Chairman Cox made a similar point while speaking in Brussels last week. He suggested that IFRS can be a powerful force to integrate our financial markets but that cannot happen if IFRS is not applied faithfully and consistently across borders.
I believe the goals of ending reconciliation may be jeopardized if different jurisdictions adopt their own versions of IFRS and, in effect, create a whole host of new home country GAAPs that all just happen to go by the name of IFRS. I have previously spoken about Corporation Finance's process for reviewing foreign private issuer filings made in IFRS,16 and about the importance of faithful and consistent application. We are not looking to dictate the interpretation of IFRS. We are not looking to change IFRS. We are focused only on the quality of its application in the interests of investors. Our work plan with CESR is an important resource for sharing information between the SEC staff and CESR staff about trends and emerging issues in the application of IFRS, and consulting with the relevant CESR member jurisdiction regarding the application of IFRS in any particular foreign private issuer's filings. We seek to use those consultations to further the faithful and consistent application of IFRS and to avoid having our own reviews unilaterally result in new IFRS interpretations which would change the standard. The bilateral agreement with the UK's FSA and FRC that the Commission announced last week is the first framework for the confidential exchange of information under the joint work plan with CESR; we expect that future agreements in the coming months based on the model "protocol" agreed in principle with CESR last week should also advance these efforts.
With regard to our reviews of IFRS filings, I can let you all know that we continue to take them very seriously and we have made good progress with them in the last three months. We have so far posted to our website 46 completed reviews; we have another 25 completed reviews that are awaiting the expiration of the 45-day period after completion before we post them to our web. There are also 36 other reviews which are pending with comments issued, and there are some reviews have been completed with no comments issued.
Because it received some press attention last weekend, I thought I would pause for just one moment and comment on the planned Concept Release and this idea of giving U.S. issuers the choice to report in IFRS. As the Commission's press release indicated, we are developing a Concept Release on the question of allowing U.S. issuers a choice to report in IFRS or U.S. GAAP. We are, by definition, at a very early stage in our thinking on this question. Already, however, some vocal critics have attacked the idea of allowing U.S. companies to choose to report either in IFRS as published by the IASB or in U.S. GAAP. I would note that I do not think these outcries are in any way a criticism of IFRS or of U.S. GAAP; they seem to be complaints specifically about the idea of companies having a choice. Former Chairman Arthur Levitt was quoted in last Saturday's Wall Street Journal as saying, "The menu system, I believe, leads to earnings management, and that should be avoided."17
In response, though, I would just reiterate that we are at a very early stage and any concept release will actively seek comment from the whole range of interested parties. We're happy to listen to anything anyone has to say on this topic. We also have heard, at our Roundtable and otherwise, that if U.S. companies have a true choice between IFRS and U.S. GAAP, then market forces may well be the driver leading companies to select one accounting system over another. In other words, companies will not have the luxury of choosing one accounting system over another just because of the effect on some particular line item. Rather, analysts, investors, rating agencies, and the like will have a significant impact in driving companies to report under a particular system based on their peers and industry practices in order to promote comparability (and credibility) for the benefit of users of financial statements. And just as a very preliminary assessment on my part, it seems to me that investors want a robust and reliable financial reporting system that is based on high-quality and consistently-applied accounting standards, and they are already capable and willing to review financial information presented either under IFRS or under U.S. GAAP.
I mention all of this because it seems consistent with what we heard from various parties-investors and other capital market participants-at the Roundtable. We may hear the same points or we may hear different ones once any Concept Release is published. I for one look forward to getting those comments. I am also eager to hear when U.S. companies and others involved with their reporting could be ready to report in IFRS. I understand that U.S. colleges are generally not teaching IFRS in accounting programs, and IFRS is not tested on the national CPA exam.
4. Small Business Capital Raising and Private Offering Matters.
As I also previewed in Dallas, using input from the report last year of the Commission's Advisory Committee on Smaller Public Companies18 and recommendations from a number of other sources, we are actively considering making recommendations to the Commission that involve private offering matters and related relief for smaller public companies. Why is this a topic for this conference? Well, changes affecting Rule 144 could have an impact on offerings conducted under Regulation S, especially as those relate to U.S. companies offering their equity securities offshore; a new Regulation D exemption for larger investors, with some form of enhanced solicitation permitted, could result in parallel changes in Rule 144A offerings; extending some of the benefits of Forms S-3 and F-3 to Form S-1 and F 1 issuers could provide more flexibility in capital raising for foreign private issuers. I am not suggesting that any of this will result in major changes in capital raising by foreign private issuers or in Regulation S offerings, but there could be advances, and we are moving forward, so keep your eye on this space this year.
5. Corporation Finance Website.
One of our key projects, at least as it relates to the bar, and one of particular importance to me, has been our efforts to upgrade our section of the Commission's website.19 It is my hope that what we have done has enhanced significantly both the quality and the availability of the information we provide (including the Division's interpretive advice). The site, I hope, can be a useful resource for public companies, their counsel and accountants, investors and others. The website now lays out all of our staff guidance and interpretations along subject matter lines. In addition to the new format, we are also in the process of updating all of our specific guidance on a subject-matter by subject-matter basis.
Given the focus of this conference, I might also point out that we do have an area of our website that is devoted specifically to relevant topics for foreign issuers and those that work with (or invest in) them.20 For example, on our "foreign issuer information" page you can find links to the deregistration rules, as well as to the Division's opening statement at the public meeting where the rules were adopted. These documents are all available elsewhere on the Commission's website of course, but finding them outside of our page would take multiple steps and require that you go to disparate places on the site. You will also easily find a link on our "foreign issuer information" page to all the various resources the Commission has on the topics of IFRS and ending reconciliation. We are trying to keep that "corner" of the site up to date as well, and I would encourage everyone to visit it frequently and to give us your comments and feedback about how it can be more useful and a better resource for you and for the foreign registrant community.
In closing, let me just thank all of you for your time and attention and the invitation to speak here today. I am looking forward to participating in the panel that follows with Bud Rogers and John Huber, and I would be happy in that forum to take any questions anyone might have (although I reserve my right to have Bud or John answer any hard ones). Thanks.