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Speech by SEC Chairman:
Making Disclosure More Useful for Public Company Directors


Chairman Christopher Cox

U.S. Securities and Exchange Commission

Keynote Address to the Stanford Law School Directors' College
Stanford University
Palo Alto, California
June 23, 2008

Thank you, Sy [Lorne, co-director of Stanford Law School's Directors' College], and thank you, Joe [Grundfest, William A. Franke Professor of Law and Business at Stanford Law School and co-director of Directors' College], for inviting me once again to join in the Directors' College. This is a wonderful opportunity for so many of the directors of America's public companies to sharpen their expertise in a number of areas that are important to doing your jobs. The sessions you've had — on subjects ranging from the duties of directors under Delaware law, to corporate governance ratings, to the board's responsibility in determining executive compensation — are exceptionally topical. And the organizers and presenters — including Professor Grundfest; my predecessor as Chairman, Rod Hills; Sy Lorne; Vice Chancellor Stephen Lamb; Ken Langone; and Penny Pritzker — are some of the most knowledgeable in these areas in the entire nation.

Even this evening's setting here on the Stanford campus — or perhaps I should say especially this setting — is perfect, as was the lovely dinner we just had. I'm personally grateful the entree was steak, and not barbecue — because I already had that in the Wall Street Journal this morning.

Just a word about that article, since it appeared only today. As someone who's been in public life for over twenty years, I know as well as anyone that occasionally this sort of thing can come with the territory. I long ago ceased being surprised by stories containing inaccurate or incomplete reporting as a means of conveying a particularly dramatic point of view. The best response to stories like this is simply to put your head down and not lose a step doing the best job you possibly can on behalf of those you serve. For my part, I plan to do just that.

Last year at this conference, I talked about making disclosure customer friendly for the benefit of investors. This year, I'd like to talk about making disclosure more useful for all of you, as directors who are representatives of the investors' interests. That is the very purpose of the Directors' College, after all: to help you meet your boardroom obligations in an environment of ever-increasing financial, commercial, and legal complexity.

The shift from the dominant CEO model of the 1990s to greater responsibility and authority for directors in the post-Sarbanes-Oxley environment has carried significant implications for corporate governance, and it has made your jobs a lot more difficult. It would be challenge enough to face this increased director responsibility in a commercial world that is now more global and more complicated than ever before, and in a legal environment that is focused now more than ever on the liability of directors. But compounding this has been the contemporaneous development of ever more complex accounting rules and interpretations that make financial statements and other financial reports more difficult for directors to use and understand.

Over the past year, the SEC has been tackling this problem head on. Last July, we chartered the Advisory Committee on Improvements to Financial Reporting to examine the entirety of the U.S. financial reporting system with a view to increasing its usefulness to investors and directors, as well as other users of financial information.

The CIFiR committee has already made interim recommendations this spring, and we expect their final report later this summer. The committee's recommendations thus far are premised on their finding that in practice, our system of financial reporting has sometimes been more responsive to the interests of preparers and auditors than to the needs of investors and the directors who represent them. That has led them to propose better representation for users of financial statements on the Financial Accounting Standards Board and the Financial Accounting Foundation. It has also led them to propose that the determination of how to correct financial statement errors should be based on the needs of current investors.

I have no difficulty accepting the committee's conclusion that the large volume of accounting standards, including individual standards, amounts to something that is just too long and too complicated. That's even more true when one adds to it all of the interpretations and the detailed application guidance from a variety of public and private sources. It's gotten so that not only investors and directors, but preparers and even auditors can't always efficiently find the complete body of authoritative literature on an accounting issue.

The CIFiR committee's recommendations for reform, including explicit priority setting for new standards that would be accomplished with the help of a new Agenda Advisory Group, could help with the FASB's work going forward. Just as important are the committee's recommendations for periodic assessments of existing standards. Those assessments would be conducted by the FASB with input from this new Agenda Advisory Group. The focus would be on determining if the existing standards are continuing to operate as intended.

Yet another problem for investors and directors using today's financial reports, according to the CIFiR committee, is that GAAP contains too many detailed rules with too many industry-specific exceptions and alternative accounting policies that might be used for the same transaction. What makes that problem worse is that some of these rules have all-or-nothing results, which stem from bright line tests.

The reason this matters to you as directors is that it can allow companies and auditors to reach a technically compliant conclusion that might nonetheless be inconsistent with the underlying economic substance of a transaction.

To remedy this problem with GAAP, the committee proposes moving away from industry-specific guidance to activity-based guidance. They also want to reduce the number of alternative ways that are available under GAAP to account for the same transaction, and the possibility of proportionate recognition, rather than all-or-nothing results.

The overarching purpose of these and other recommended reforms is to design accounting standards with more general principles and fewer detailed rules, in order to prevent the manipulation of technical requirements to reach pre-conceived results. All of these improvements to U.S. GAAP could go far to making the financial statements that you as directors rely upon to do your jobs more useful to you, and more understandable and comparable across industries.

But the biggest challenge to directors using financial statements in the global economy is the lack of comparability. It is a significant barrier to comparability that at present, U.S. companies follow GAAP, while in most other countries, publicly-traded companies are increasingly following IFRS. As you know best of all, the capital markets in which your companies raise funds today are truly international. Not only your companies but your competitors now have the ability to raise funds almost anywhere in the world.

For their part, investors can now trade securities in foreign markets with almost the same ease as they can in their home markets — which is one reason that today, two-thirds of U.S. investors own foreign securities.

It is within this context of not only the growing volume of cross-border trade, but the growing globalization of investing, that the need for a high quality global accounting standard has become so acute. As a director, your job of analysis will be made far less difficult if the benchmarks you use can truly compare apples to apples. I daresay that many of you serve as directors of companies that report the financial results of your subsidiaries in other countries using IFRS, while you're using U.S. GAAP in America — so that even internally, you are not always speaking the same language.

As you know, as Chairman I have been working hard to make a global set of high quality, transparent accounting standards a reality. But interestingly enough, the history of U.S. support for this is about half as old as the Commission itself. For over a third of a century, the United States has contributed both money and expertise to this effort.

Fast forward to 2008 — and IFRS are now mandated or permitted in over 100 countries. And since I became Chairman, the Commission and its staff have been on the front lines of the effort — first, to build toward U.S. GAAP-IFRS convergence, and second, to integrate the U.S. capital markets with financial reporting around the world.

Last year, we eliminated the reconciliation requirement for foreign issuers who file in our markets using IFRS. That effectively gave foreign issuers in the United States a choice between using U.S. GAAP or IFRS. We then published a concept release last August, examining the question whether — and if so under what circumstances — U.S. issuers should be allowed the same choice.

To get more information about this question, we held two Roundtables in December. The participants in those Roundtables included more than two dozen experts on the topic of U.S. issuers using IFRS. And just last week, John White, the Director of our Division of Corporation Finance, and Conrad Hewitt, our Chief Accountant, participated in a forum on IFRS sponsored by the Financial Accounting Standards Board. That forum was an important milestone because it made it clear that the movement to IFRS by U.S. companies was rapidly becoming a question of not whether, but rather how and when.

I have charged the staff with the mission of developing recommendations on these topics for later this summer. But in advance of completion of that work, I want to offer my own observations on some of the views we have heard relating to IFRS.

First, there seems to be continued wide acceptance of the long-term goal of implementing a high quality set of global accounting standards. The Commission first articulated this goal many years ago, and increasingly investors and issuers have expressed their support for the notion that a single set of reporting standards is better than multiple sets.

Second, while Europe had to replace its many national GAAPs with IFRS on a crash basis, the U.S. has no such constraint. U.S. GAAP is not only high quality and transparent, but it is supported by a reliable infrastructure that would take a good deal of time and expense to replace. In light of these differences, for the U.S. to adopt the "big bang" approach in the near term, in the way that Europe did in 2005, seems needlessly risky.

Instead, the U.S. may well want to establish a date certain, but one that is sufficiently far off in order to permit what is likely to be an expensive mandate for U.S. issuers to be comfortably met. At the same time, transitioning to IFRS more gradually in the meantime would let the U.S. establish the knowledge base and systems we need to sustain it before a do-or-die switch is required for everyone. That could also reduce costs for the larger number of filers who wait until eventually a switch is required. One way to do this might be to give issuers in the near term the option of using IFRS as "early adopters," but only if doing so would enhance the comparability of their financial statements — for example, with others in their industry group.

A third observation is that we need to update our IFRS roadmap. The "2009 or sooner" date in the roadmap that took us to lifting the reconciliation requirement was helpful in accelerating the U.S. GAAP-IFRS convergence project. That was true even though the roadmap was a staff position — to be sure, endorsed by me as Chairman, but not a formal Commission action. Now, a new roadmap, hopefully with the added certainty that would attach were it in the form of a formal Commission rule, is necessary to ensure that accounting firms train their auditors; that issuers begin to examine how to change their information technology systems; and that universities and technical schools update their curricula.

In providing this kind of certainty for planning purposes, the Commission would simply be organizing and rationalizing an effort that has already been underway already for several years in the marketplace. The aim would be to put each of you as directors in a better position eventually to have a high degree of comparability in financial reports from all of the regions in which you do business. We would also want to improve the ability of the ever-increasing number of U.S. investors in foreign securities to compare their U.S. and global investment choices. Each of these aims is part of our overall mission to help promote investor protection through full and fair disclosure of material information in a way that is most useful to investors, and to each of you as directors.

Earlier I said that accounting and financial reporting using U.S. GAAP are increasingly complex, and that our CIFiR committee will soon issue its final recommendations on how to address this problem. There is an equally big challenge that stems not from the complexity of accounting, but from the dozens and scores and hundreds of SEC forms that companies and investors and other regulated persons need to use in order to meet the Commission's requirements.

The lack of usefulness in the way this information is presented to you as directors is obvious. In fact, you almost certainly couldn't use it in its raw form, unless some intermediary cleaned it up for you and made sense of it. As you know, we're trying to rationalize our SEC disclosure in a number of different ways, including through data tagging with XBRL, so that you can get the information you need in a way that's not tied down to the paper forms that originated with the creation of the SEC nearly 75 years ago.

But if using XBRL to atomize the data in a form is a good idea, so that each figure has a life of its own and you can reassemble any of it from any form in any way you wish — wouldn't it be an even more revolutionary idea to blow up the forms themselves?

With the help of several big thinkers, including particularly Professor Joe Grundfest and the Rock Center here at Stanford, we are kicking off a special study this week to ask precisely that question. It's called the 21st Century Disclosure Initiative, and it has incubated over the past three years from an original idea of Alan Beller, the SEC's former Director of the Division of Corporation Finance.

Alan gave his idea the code name Project Alpha. But that sounded like something out of Roswell, New Mexico, so the staff wisely decided the project needed a new name. What's more, the General Counsel told us that the name had already been taken. It seems it was used by the U.S. Joint Forces Command, as the name for an analysis group focused on transforming our military into a largely robotic fighting force by 2025. (You won't be surprised to learn that this particular Project Alpha has been discontinued.)

The goal of the SEC's 21st Century Disclosure Initiative is not to produce robots by 2025, but to produce a comprehensive conceptual blueprint by the end of calendar 2008 for overhauling completely the SEC's current forms-based system and replacing it with one that truly meets investors' needs.

To encourage a fundamental rethinking, the project won't proceed from the premises of the current reporting system. It will start from scratch, from the ground up, freed from any conventions. It will begin with the most basic purposes of the reporting and disclosure system — the needs of investors, directors, and other users of disclosure — viewed in the context not of 1934, but of today's markets. Based on this assessment, the project will take a critical look at the current approach and then conceive a blueprint for the ideal disclosure system of the future.

What might this mean?

Well, it would mean thinking about how we could best match the capabilities of today's information technology with the SEC's regulatory aims and the needs of investors.

It would mean considering different ways that disclosure information could be collected from registrants.

It would mean thinking about how that information, once collected by the SEC, is organized in digital form.

The overarching purpose of this conceptual experiment will be to maximize the ability of investors to use disclosure information more quickly, in a greater variety of ways, and at the level of detail they desire.

The final phase of this project will be the establishment of a Federal Advisory Committee to review the blueprint during 2009, and to continue the discussion in a public setting with input from investors, directors, registrants, analysts, and every other group of stakeholders. If the Advisory Committee takes this initiative to the next level, it could make specific recommendations for Commission action.

Given the ambitious scope of the project, the SEC is fortunate to have enlisted the support of a project director who is especially expert in meeting investors' disclosure needs, Dr. William D. Lutz. You know him because he has published numerous books and articles on the importance of disclosure presented in plain language, and has significant experience in working with the SEC on disclosure issues. He'll be provided with a dedicated team of specialized professionals and support staff that will work as a stand-alone unit within the Commission.

It seems especially appropriate, in this the Commission's 75th year, to engage in a thorough reevaluation of how we execute our full-disclosure mission. Not only will this help us to envision heretofore unimagined possibilities for the future, but in the here and now it will help us evaluate how well we are doing using our current system.

I am encouraged by the work the Commission and our staff has set in motion on the initiatives I've just described, and on an entire range of issues — as well as the work we have completed in the past few years. And despite the difficult period that this has been for every one of you in American business during the past year, as a result of the market turmoil not only here in America but around the world, I'm confident in the future of our markets. I know that by working together, we will maintain our nation's economic growth through the investment, innovation and productivity for which each of you here is responsible.

I want to thank Professor Grundfest and the Directors' College again for the outstanding program that you have assembled today. This forum is helping to foster a critically important discussion on how best to strengthen the management of America's public companies, and how to help our markets resume their primary role as an engine of prosperity — for the benefit of people here in the United States, and people throughout the world. At the SEC, we know we share our important responsibility for investor protection with America's directors — and we are proud to be your partners. Thank you for inviting me, and thank you for all you do to make our nation more prosperous, and our world a better place.


Modified: 06/24/2008