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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks at the 29th Annual SEC and Financial Reporting Institute Conference


Paul A. Beswick

Deputy Chief Accountant, Office of the Chief Accountant
U.S. Securities and Exchange Commission

Pasadena, California
June 3, 2010

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author's colleagues upon the staff of the Commission.


Good morning. It is a pleasure to speak to this group. This is the first year that I have had the opportunity to speak at this conference and I am excited about the opportunity. Today, I would like to address two issues: the structuring of transactions to achieve an accounting result, and the SEC staff's work plan on incorporating IFRS.

Structured Transactions

As you know, there has been an ongoing struggle between standard setters and some practitioners in the area of structured finance. It has seemed that just as soon as the Financial Accounting Standards Board ("FASB") comes out with a new model a race begins to find ways around the model to achieve the practioner's desired accounting.

As you know, last year the FASB issued a new accounting standard on consolidations, FASB Statement 1671, which became effective earlier this year. Broadly speaking, the goal of this standard is to correct deficiencies that became apparent with the old consolidation rules. For instance, under previous GAAP commercial paper conduits, structured investment vehicles, and other structured finance entities were reported on-balance sheet by their sponsors only if the sponsor absorbed the majority of expected economic losses. Of course, those expected losses turned out to be based on subjective mathematical calculations that often bore little relation to who absorbed the actual losses and controlled the entity when it really mattered; that is, when things didn't go as expected.

To avoid the old trap of writing detailed rules that ultimately provide a roadmap for new structuring efforts, the FASB has tried with this new standard to provide an objectives-oriented standard that doesn't simply serve as a catalyst for ever more creative structuring. However, it would be naïve to think that such an effort would not be tested. The success or failure of the new standard will be determined not just by the words on the page, but by the efforts of practitioners, both preparers and auditors, as they make their judgments under this objective-oriented standard.

I thought I would share some observations with you about how I believe the issue of judgment should be approached in this area. The core principle of Statement 167 is that a reporting enterprise should consolidate variable interest entities in which it has a controlling financial interest. This core principle is based on a concept of control that manifests itself as a combination of power over the entity and exposure to losses or benefits of the entity. Further, the new standard makes it clear that it places a premium on determining the substance of the arrangement and not just the form. Nonsubstantive terms should be disregarded when determining who makes the key decisions that most significantly impact an entity's economic performance.

Under the old model, consolidation was sometimes avoided by selling expected loss notes to a third party that absorbed a majority of the expected losses of a structured entity. Unfortunately, in many of these cases losses in unusual or distressed circumstances continued to accrue to the sponsor and it was the sponsor that ultimately made the important decisions that affected the entity when it really mattered. While the new rules make it more difficult to argue an expected loss note changes who controls an entity, we have heard of strategies that involve selling beefed up expected loss notes in an effort to continue to argue that the sponsor is simply an agent or service provider to the real owner. We will be highly skeptical of this type of "expected loss note on steroids" approach. When the sponsor is obligated, either explicitly or implicitly, to support the structure or otherwise absorb losses in distressed circumstances, it will likely be the sponsor that consolidates the vehicle.

A variation on this theme involves the sale of kick-out rights to a third party investor in the structured entity who then has the unilateral power to remove the sponsor as decision-maker and replace the sponsor with a decision-maker of the third party investor's choosing. The goal here is to argue that the sponsor is simply an agent or service provider of the real owner, who can hire or fire the sponsoring entity at will. While this may be supported in some circumstances, we'd be skeptical of whether such rights are substantive in situations in which the sponsor designed the structure and retains significant residual risk, whether explicitly or implicitly, in the structured entity. In order for kick-out rights to be substantive there cannot be significant financial or operational barriers, to the exercise of those rights by the third party. While facts and circumstances should be considered, we'd be especially skeptical in situations in which kick-out rights have been included to an arrangement simply to avoid consolidation by the sponsoring enterprise.

With respect to shared power, the FASB's new standard notes that in circumstances in which multiple unrelated parties must jointly consent to all significant decisions that affect the structured entity then none of the interest holders would consolidate. This could be a tempting prize for a would-be structurer, and we've heard of efforts to create structured entities with at least the appearance of shared power in an effort to remove problem assets from a sponsoring entity's books. Unfortunately, many of these structures appear to leave most of the downside risk with the sponsoring entity, raising the question of whether the shared power provisions are substantive. A structure that permits deconsolidation without transferring substantive power merits extensive professional skepticism.

These are just a couple of examples of areas where I believe judgment needs to be applied to determine the substantive nature of a structured transaction, and I bring them up not as a prescriptive list of red flags or aggressive approaches but to highlight the role of judgment in evaluating substance in this area. My remarks should not be taken to mean that the staff has a preconceived view that sponsors of investment vehicles should always consolidate entities that they design, manage, or transfer assets to; or even that structures similar to the ones I've described might not in some cases contain substantive features that result in an entity appropriately determining that it is not the primary beneficiary of a structure. However, my comments should be taken to mean that my office takes the implementation of the new consolidation requirements very seriously and will approach structured transactions with an eye towards the development of practices that conform to the spirit of the new model. It is clear that significant judgment is required in determining whether a controlling financial interest exists in complex fact patterns, and, of course, my office is available if a registrant would like to consult regarding its accounting for unusual transactions where they believe application of GAAP is unclear.

International Accounting Standards

Earlier today, Jim [Kroeker] mentioned that I was going to spend time discussing International Financial Reporting Standards ("IFRS") and how the staff intends to approach completing the work plan2. This is not intended to be an exhaustive list, just some of the highlights of our planned efforts. Hopefully after today, you will have a better understanding of the amount of effort we are undertaking.

In the Commission Statement in Support of Convergence and Global Accounting Standards3 ("Statement") the Commission directed the staff to execute on a work plan.

The work plan is intended to inform the Commission on whether and, if so, how to incorporate IFRS into the financial reporting system for U.S. issuers. The staff is expected to publically report periodically beginning in October 20104. In executing on the work plan the staff expects to get information from number of sources including investors, issuers (both U.S. and foreign), auditors (global and domestic), other regulators, standard setters, and academics. We will reach out to these various sources in a number of ways including staff research, survey of academic research, and outreach through comment letter requests, roundtables, and targeted interviews.

The Statement identifies six areas the staff is expected to focus on. I believe that it is important to work on both questions of 'whether' and 'how' to incorporate IFRS at the same time because when the Commission is deciding whether to incorporate IFRS they should be in a position to articulate how any transition would occur. Throughout our efforts we are going to consider the past experiences of other jurisdictions when they incorporated IFRS into their regulatory regime. We plan to utilize our working relationships with IOSCO to assist in obtaining this information.

"Whether to Incorporate IFRS"

The first two areas in the work plan — sufficient development and applications of IFRS for the domestic reporting system, and the independence of standards setting for the benefit of investors — are focused on whether we should incorporate IFRS into the financial reporting system for U.S. issuers5.

The Standards

In determining whether IFRS is sufficiently developed and consistent in application, the staff will focus on the comprehensiveness, auditability and enforceability, and consistent and high-quality application of IFRS.

In assessing these areas I'd like to share a couple thoughts. First, we are going to consider how IFRS is utilized in different capital markets. While a number of publications indicate that over 100 countries have adopted IFRS, a question I believe that needs to be clarified is how have they adopted IFRS. In many cases the jurisdiction in question is making the evaluation of IFRS on a standard-by-standard basis and in some cases supplementing, clarifying, or minimizing the choices available under IFRS. This is an important distinction that is being made and one that I expect that the Commission will need to evaluate.

When we are considering the standards, we need to break the standards into two categories, those subject to the FASB/ International Accounting Standards Board ("IASB") Memorandum of Understanding6 ("MOU") process and the remaining standards. For standards subject to the MOU we will consider the output from both boards and whether they continue to be high quality. For the remaining standards, the staff has begun to catalog differences. However, we are focusing on whether the standards are different at the principle level and not where the mechanics of the standards are different. Let me give you two examples. When I evaluate the accounting for Property Plan & Equipment "PP&E" under U.S. GAAP and IFRS, I believe that the principles are the same. Both require capitalization of the acquisition of PP&E at historical cost. Sounds simple enough. The differences arise from the detail mechanics of the standards. IFRS requires that when PP&E comprises individual components with different lives, each component is depreciated separately while U.S. GAAP permits, but does not require, the separate accounting for the components. These types of differences in mechanics could be addressed on a prospective basis. Now, let me compare this with the accounting for uncertain tax positions. U.S. GAAP has a specific recognition and measurement threshold for uncertain tax positions, while IFRS relies on the general contingency accounting guidance for uncertain tax positions. This type of difference will need to be addressed at the standards level.

Another aspect we will need to understand is whether the standards are being applied differently. The staff is going to review filings of foreign private issuers and other financial statements from non-registrants that prepare financial statements under IFRS to gain insight about the comparability of financial information. We are also going to evaluate whether industries have taken steps to promote comparability. This review is already underway. I expect that we will make our findings public when we are complete.

Standard Setting Process

The second area on whether to incorporate focuses on the standard-setting process and the need for an independent standard-setting process for the benefit of investors. Here, we are going to focus on a couple of areas including, oversight and composition of the IFRS Foundation and its IASB, and the IASB's standard-setting process. This is one of the areas where we already have a head start based on our experience from our past rule making and involvement with International Organization of Securities Commissions ("IOSCO"). It is important to remember that we need to assess not just the design of the standard-setting process, but also how the process operates in practice. One of the more recent changes in the oversight is the creation of the Monitoring Board. The staff will analyze for the Commission's benefit the extent to which the Monitoring Board is functioning as designed so as to support a Commission decision regarding whether to incorporate IFRS. Additionally, another aspect we need to consider is determining ways to secure a stable funding for the U.S. portion of the IASB's budget.

"How to Incorporate IFRS"

There are four areas we are considering regarding the 'how' to incorporate IFRS. But let me stress, the staff acknowledges the importance of evaluating how to transition. Some may argue that this is the more important aspect of the work plan. We are sympathetic to the magnitude of the change we are evaluating. It is important to remind people that in many of these areas we cannot mandate changes, but rather we hope to inform the Commission as to the potential impacts.


As contemplated in the work plan, the first area I would like to mention is investor understanding and education regarding IFRS, and how it differs from U.S. GAAP. The benefits of a global set of standards will only be realized if investors have a thorough understanding of those standards. The staff plans to discuss with investors their understanding of IFRS, how they educate themselves about changes in accounting standards in general, and how they use financial information.

Other Regulatory Regimes

The second area the staff will focus on is understanding how other laws or regulations would be affected. Accounting standards impact not only the SEC's mandate but also other regulatory filings (such as bank call reports), tax reporting, and statutory dividend and stock repurchase restrictions, among other things.

The matters we will be focusing on in this area include meeting with other regulators to understand how they utilize financial information. For example, we have met with representatives from the Federal Energy Regulatory Commission's Chief Accountant's office to obtain their perspectives on how incorporating IFRS would affect their regulatory environment. In our meetings, we gained insight into some of their needs including the need for a rate-regulated asset standard. As an another example, the staff plans to meet with representatives from the Internal Revenue Service to consider how U.S. GAAP is incorporated into the tax code. The staff will be focusing on the more significant issues in the tax code including LIFO. The final example for this area is to consider the implications for regulation of the audit industry and related standard setting process. The staff will be identifying areas where existing auditing literature is potentially not compatible with IFRS. It is interesting to note that currently firms are issuing audit opinions on statements prepared under IFRS using Public Company Accounting Oversight Board ("PCAOB") standards, so if this were a considerable challenge we should have already been aware of it. As part of this process, we will be cataloging changes that need to occur in the PCAOB standards if we were to incorporate IFRS.

Impact on Companies

The third area the staff will focus on is understanding the impact on companies, both large and small, including changes to accounting systems, changes to contractual arrangements, corporate governance considerations, and litigation contingencies. We will meet with preparers to assess the level of effort needed to incorporate IFRS, including a separate consideration of the MOU projects. The staff will also consider the experience of other jurisdictions on the level of effort that will be necessary. The staff is cognizant of the fact that the U.S. internal control reporting regime will require consideration when evaluating the effect on any potential transition. It is important to note that the 'how' we incorporate can significantly mitigate some of the issues. For example, the issue of contractual arrangements appears to be a lot easier to analyze if U.S. GAAP continues to exist. We will also consider whether there are transition techniques that could mitigate the cost. For example, if we were to permit companies to account for the components of PP&E on a prospective basis, the cost of transition may be lessened.

Human Capital

The final area is to determine whether auditors and preparers are sufficiently prepared, through education and experience, to incorporate IFRS. Others impacted by a change to IFRS would be individuals who are in corporate governance (e.g., audit committee members), specialists (e.g., actuaries), attorneys, regulators, state licensing bodies, professional associations, industry groups, and educators. The staff plans to reach out to various constituents groups to understand the current state of readiness, the perceived level of effort to consider the changes to U.S. GAAP, and whether there are any transition techniques that would be more useful to ease transition. The staff intends to focus on this area last when there is a better understanding of the information obtained from the staff's other efforts on completing the work plan.


In closing, thank you for your time today and I would be happy to address any of your questions if we have time in this session or later today in the afternoon session.



Modified: 06/17/2010