Speech by SEC Chairman:
Mutual Fund Prospectus Simplification; Financial Statements Using IFRS; Small Business Capital Formation, Simplified Reporting, and Disclosure Reforms
Chairman Christopher Cox
U.S. Securities and Exchange Commission
SEC Open Meeting
SEC Headquarters Office Main Auditorium
November 15, 2007
Good morning. This is a meeting of the Securities and Exchange Commission under the Government in the Sunshine Act on November 15, 2007. We have a full agenda today with five significant actions to consider. The first is making major improvements to mutual fund disclosure for the benefit of retail investors.
Today, mutual fund investors don't get a clear and concise description of the fund's investment objectives and strategies, or the fees, risks, and performance of the fund. There's no summary document written in plain English so that investors don't have to dig through pages of legalese for the key information they're after. What's needed is a summary that will quickly give a retail investor a basic understanding of the fund, and that will permit ready comparison of this one fund to others the investor might be considering.
In SEC terms, that means we need a new prospectus disclosure framework for mutual funds. And that is the proposal we have before us today.
Under current rules, investors get to read the mutual fund's full-length prospectus, but if they want something more readable, they either have to resort to sales material, which is usually too skimpy and doesn't allow for quick comparisons, or they can consult summary materials prepared by outside analysts, which aren't authoritative, and also usually don't follow a standardized form that facilitates comparison shopping.
Today, only a few mutual funds actually prepare a short, readable document that gives concise information about the fund — and there is no standard format for those summaries. To change that, the Division of Investment Management is proposing that we revise our disclosure rules, to authorize the preparation of a user-friendly "summary prospectus" that investors could receive as a stand-alone document. The proposal would also require that a mutual fund's full prospectus be available on the Internet.
Anyone interested in scrutinizing mutual funds for detailed information on an immediate basis would have access to it, any time of the day or night, on a web site. And anyone who wants the hard copy of the long, printed document can demand it, up front or later on. The online information would be available in a progressively more detailed format, so that investors can move from the summary to the particulars with a click of the mouse.
This layered approach to the web disclosure will let every customer obtain the level of detail that he or she wants. And by standardizing the way this important information is provided to investors, in both detailed and summary form, this proposal will go far to enable them to analyze and compare mutual funds.
This proposal is a giant step forward for investors, and it's an important complement to the Commission's other initiatives to make the very best information available to investors online. Recently, for example, we adopted rules that open up the way for investors to get mutual fund risk/return summaries in interactive data format. When eventually all mutual fund reporting is done this way, investors will have an exceptionally useful new tool to analyze and compare mutual funds, and to decide which fund is the most appropriate for their needs.
I should add that this move to using interactive data isn't just underway in America — it's going on around the world. I just returned from a week of meetings with foreign securities commissioners, and received reports of progress on this front in many countries — some of which are well ahead of the United States in putting this new technology to work for investors. And undoubtedly this new publication, XBRL for Dummies [Chairman Cox holds up book] — will only accelerate the trend toward interactive data reporting. [Laughter]
I expect that 2008 will be a watershed year for interactive data, and today's proposal is part of that progress. The summary prospectus that's being proposed is perfectly suited for delivery to investors in an interactive format. That will be especially useful for individual investors in 401(k) plans — and of course there are a lot of them. Americans have invested well over $3 trillion through these retirement plans, and over half of that is invested in mutual funds. A concise mutual fund summary that provides individual investors with clear disclosure about investment objectives and strategies, risks, costs, and performance could greatly benefit their retirement planning.
I should note that the proposal we're considering today is the product of many months of hard work. It began last year, when the Commission held a roundtable at which investor groups, mutual funds, investment analysts, and other participants discussed how the mutual fund disclosure framework could be improved to provide investors with better information. That process helped us to focus on the importance of providing key information about the fund, and it helped us to decide which information is most important to investors in making an investment decision. Out of that brainstorming came the idea for a shorter, more readable document that contains this key information, as a supplement to the more detailed documents that should always be available to investors and the market. So I'd like to thank these participants, and others who have made the recommendations we received during the past year, for helping us bring today's effort to fruition.
Of course by advancing these ideas as a formal Commission proposal, we're initiating a formal public comment process. I look forward to receiving substantial additional comment from investors and others on the approach we are proposing today.
Having given a concise, plain English summary of this proposal, now I'd like to recognize the Director of the Division of Investment Management, Buddy Donohue, for a more detailed (not to say lengthy or legalistic) description. As I do so, I'd like to thank Buddy and his staff in the Division, in particular Susan Nash, Brent Fields, Tara Buckley, Kieran Brown, and Sanjay Lamba, all of whom worked long and hard to help bring this release before us for consideration today.
I'd also like to thank the many other staff of the Commission who helped in this effort, in particular, in the Division of Trading and Markets, the Division of Corporation Finance, the Office of the General Counsel, the Office of Investor Education and Advocacy, and the Office of Economic Analysis.
[After discussion, publication of the proposed mutual fund prospectus reforms for comment was approved on a Commission vote of 4-0.]
The next item on today's agenda is just as significant as the last. It comes to us as a joint recommendation from the Division of Corporation Finance and the Office of the Chief Accountant. What they are recommending is that we formalize our current acceptance of filings by foreign private issuers containing financial statements prepared using International Financial Reporting Standards, and that we do so without requiring those issuers to reconcile the financial statements to U.S. Generally Accepted Accounting Principles.
IFRS is now mandated throughout Europe, and increasingly in Asia and throughout the world. Addressing the use of IFRS in U.S. markets is thus vitally important for American investors, and it will be critical in determining the role that the American market will play in the global capital markets.
The Commission has long supported international regulatory harmonization, and the development of a set of high quality, truly global accounting standards. But we have always said that our recognition of IFRS depends upon its being just that — a single set of internationally accepted accounting standards — and not a multiplicity of accounting standards interpreted differently in every country that uses them. For this reason, today's amendments allow an eligible foreign private issuer to file financial statements prepared in accordance with IFRS without reconciliation to U.S. GAAP, only if that issuer states, and the auditor opines, that the financial statements are in compliance with IFRS as issued by the International Accounting Standards Board.
Today's proposal is premised on the Commission's long-held view that a single set of international accounting standards would help investors understand and draw better comparisons among investment options than if they had to deal with a multiplicity of national accounting standards. International standards would also facilitate cross-border capital formation by reducing costs and regulatory burdens for issuers, who would no longer have to incur the cost of preparing financial statements using differing sets of accounting standards.
In recent years, the need for a common accounting language has become compelling. Investors increasingly seek access to foreign markets to diversify their portfolios, while companies increasingly seek capital outside their home markets. We can see this trend around the world, and not least of all in our own country — where today roughly two-thirds of American investors own securities of non-U.S. companies. That's a 30% increase from just five years ago. As a result, we have a big stake in ensuring that the companies that U.S. investors own have high quality accounting standards that are consistently applied and enforced.
The trend toward global investing that is so strongly underway makes it clear we need accounting standards that work across national borders. A single set of international accounting standards isn't just an ideal for an international marketplace — it is fundamental to the efficient operation of our capital markets. Of course, no regulatory standard is perfect, and international accounting standards are certainly no exception. But the benefits of a universal accounting language that results in consistent financial reporting for all issuers, regardless of domicile, exceed the cost and confusion created by multiple standards — even though each may have its own reasonable claim to superiority.
We proposed these amendments in June and received valuable public comment. We heard widespread support for high quality, globally accepted accounting standards as an important and worthwhile goal. We also heard some concern about the current level of convergence between IFRS and U.S. GAAP, and about whether these amendments would slow the ongoing convergence process between IFRS and U.S. GAAP. As we stated in our rule proposal, our acceptance of IFRS financial statements is based on the continuation of the robust process that the IASB and the Financial Accounting Standards Board have established to issue high quality standards, including their joint commitment for continued convergence. We continue to support the work of the IASB and the FASB to develop high quality international standards. Because investors and issuers are best served by a single set of high-quality, globally accepted accounting standards, the SEC, our fellow regulators and the market will continue to provide ongoing incentives for continued convergence.
While commenters generally agreed that IFRS have been issued through a robust due process by a stand-alone standard setter, some of them raised larger and broader questions about the IASB and the way in which it is funded and governed, and about its accountability to the public and to investors. These questions are even now being addressed. Our staff are working with other regulators around the world, the European Commission, and International Organization of Securities Commissioners on a proposed framework for formal ties between regulatory stakeholders and the International Accounting Standards Committee Foundation, which oversees the IASB. The object of this work is to establish a means of accountability from the IFRS standard-setters to the governmental authorities in each jurisdiction charged with protecting investors and regulating capital markets, including the Securities and Exchange Commission.
And to ensure that each of our proposals today is introduced with some relevant information about interactive data, I want to report that last week at a series of bilateral meetings with other national securities regulators, we discussed the global schedule for converting to interactive data reporting using XBRL tags. The first company to file its IFRS financial statements with the SEC in interactive data format using XBRL did so ten days ago, and that of course is the beginning of another remarkable development in the global convergence of financial reporting. Interactive data will help users of financial statements monitor the substance and the quality of both GAAP and IFRS reporting in ways that were never before possible, and it will also help identify and prioritize the issues that must be settled as we move toward convergence.
Today's recommendation is a significant milestone, but it is only one step in the journey for IFRS.
In August, the Commission published a concept release seeking public comment on the idea of giving U.S. domestic issuers the same option that foreign private issuers will now have to report their financial results in IFRS. The comment period for that concept release ended on Tuesday. We, and the Commission's staff, look forward to reviewing those comments carefully.
To collect more feedback from the public on this important issue of whether to allow U.S. domestic issuers to use IFRS, we will convene two roundtables later this year, on December 13 and December 17. At those roundtables we'll hear from audit firms, preparers of financial statements, the users of financial statements — including investors, analysts and lenders — and the intermediaries in the capital-raising process, such as underwriters, securities lawyers and rating agencies.
Before I recognize John White, Conrad Hewitt and the staff to describe the proposal, I want to thank the staffs of both the Division, and the Office of the Chief Accountant — in particular John, Conrad Hewitt, Ethiopis Tafara, Julie Erhardt, Paul Dudek, Michael Coco, Craig Olinger, Sondra Stokes, Katrina Kimpel and Jeff Minton — for their excellent work on this proposal. I also want to thank Shauna Steele and Sarah Otte in the Office of International Affairs and David Fredrickson in the Office of General Counsel for their excellent work.
[After discussion, the use of IFRS by foreign private issuers was approved on a Commission vote of 4-0.]
We'll now move to the final items on today's agenda — the consideration of three recommendations from the Division of Corporation Finance that will make it easier for smaller companies to raise capital, and simplify their reporting and disclosure chores.
In May, we proposed to simplify the regulations that apply to capital raising, reporting and disclosure obligations for smaller companies in recognition of the vital role these companies play in our capital markets, and in the U.S. economy overall.
The proposing releases we published were responsive to several key recommendations of the SEC's Advisory Committee on Smaller Public Companies, which issued its final report in April 2006. The Advisory Committee focused on ways that the Commission could ensure that the costs of regulation for smaller companies under the federal securities laws are commensurate with the benefits. We greatly appreciated the recommendations that we received from the Advisory Committee, and with today's action we are continuing to implement them.
In addition to its recommendations regarding the application of Section 404 requirements to smaller public companies, which we have spent a great deal of time with earlier this year, the Committee's final report included other important recommendations to alleviate undue burdens on smaller companies, both public and private, and to facilitate capital formation. Two of today's three rule amendments address primary recommendations of the Advisory Committee.
The Commission has a long history of assisting small companies in their efforts to raise capital. For more than a quarter century now, we have been sponsoring an annual forum on small business capital formation, and I was honored to open the 2007 forum here in this auditorium in September. Our focus in these forums on the removal of obstacles that can impede the growth of small companies is appropriate given our mandate to help small businesses gain access to capital. This responsibility to promote capital formation goes hand-in-hand with our responsibility to protect investors.
It would be impossible to succeed in our mission of promoting capital formation if we did not focus directly on the needs of small business. Small firms represent 99.7% of all employer firms in the United States, and employ half of the entire labor force in the private sector. Of all of the net new jobs created in our country, small business generated between 60% and 80% during each year over the last decade.
In addition, small business is leading the way when it comes to America's export economy. According to the Small Business Administration's most recent figures, small business produces over 28% of the nation's export value. Small business is also responsible for the lion's share of America's technology leadership, producing 13 times more patents per employee than large firms. And when it comes to inventions, smaller firms' patents are twice as likely as large firms' patents to be among the top 1% most cited. So we shouldn't be surprised that small business employs over 40% of all the high-tech workers in the United States.
That small firms are making giant contributions to America's global business leadership is even more remarkable when you consider that the cost of regulation falls heaviest on smaller companies. Here's a telling statistic: the very smallest firms — those with less than 20 employees — spend 45% more per employee than larger firms to comply with federal regulations.
We appreciate all of the comments and suggestions for improvement that we received during the comment period for our May rule proposals. Today we will consider adopting rules for three of them. We plan to consider the Division's recommendations on the remaining three releases in the near future.
The first release would expand the eligibility for the Commission's scaled disclosure and reporting requirements for smaller companies by making those requirements available to most companies with a public float of less than $75 million, compared to $25 million in public float under the current rule.
This change will result in more than 1,500 public companies becoming eligible to use our scaled disclosure and reporting requirements.
This release would also simplify the scaled disclosure rules, which currently appear in Regulation S-B, by integrating them into Regulation S-K, the disclosure regime that applies to larger companies. The effect of this consolidation would be to eliminate five forms that can only be filed by small business issuers and 36 separate items that comprise Regulation S-B. At the same time, the disclosure burden on these smaller companies would be no greater than before.
The second release would shorten the holding periods under Securities Act Rule 144 for restricted securities from one year to six months, and eliminate or reduce many of the current restrictions in Rule 144 in order to increase liquidity for issuers, make capital investment more attractive, and decrease costs of capital for smaller companies without sacrificing investor protection.
For example, after the six-month holding period, non-affiliates of reporting issuers will be relieved from having to comply with all conditions in Rule 144, except the current public information requirement. Moreover, there will be no tolling of this six-month period, even if a non-affiliate engages in hedging activities.
In addition, non-affiliates will no longer be required to file Form 144s, which would result in the number of Form 144s filed with the Commission dropping by nearly 60%.
The third release would help private companies with stock option plans avoid becoming subject inadvertently to the registration and reporting requirements of the Exchange Act before they have public shareholders.
Currently, if a private, non-reporting issuer has issued compensatory employee stock options to 500 or more optionholders, and has more than $10 million in assets, that issuer is required to register the stock options under Section 12(g) of the Exchange Act. Today's amendments would create two new exemptions for compensatory stock options under Section 12(g) so that Exchange Act registration and reporting requirements would not be triggered solely by a company's decisions to compensate employees with stock options.
These exemptions would provide certainty for non-reporting issuers in designing and implementing compensation programs and employee stock option plans.
All three of these rule amendments required a significant effort by the staff of the Division of Corporation Finance. I want to thank John White, Paula Dubberly, Mauri Osheroff, Betsy Murphy, Amy Starr, Gerry Laporte, Ray Be, Katherine Hsu, Kevin O'Neill and Johanna Losert for their good work.
We have a lot of ground to cover in a short amount of time, so without further delay, I will turn things over to John White and his team for additional information about the rule amendments.
[After discussion, the small business capital formation, simplified reporting, and disclosure reforms were adopted on a Commission vote of 4-0.]