Speech by SEC Chairman:
Videotaped Remarks at Tax Council Policy Institute
Chairman Christopher Cox
U.S. Securities and Exchange Commission
February 9, 2006
Good morning. It’s a pleasure to join you. I’d never miss an opportunity to step out to the Ritz—even if my appearance is necessarily virtual this morning.
Another thing I’d never miss is the opportunity to talk about taxes. You probably know I used to teach federal income tax at Harvard Business School. It was a course called “Tax Factors in Business Decisions.” I hope my students learned something from me, but I can tell you, I learned a lot from them.
I’ll never forget grading those final exams. The final was four hours long—two cases. And so the students filled up a half dozen blue books with their answers. It was a bear to grade.
But there was one student who used only one blue book—I can’t tell you how excited I was to open the cover and review this model of brevity and concision. And when I opened his test book I discovered he’d only used one page for his answer to both problems.
Here’s what he wrote: “Dear Prof. Cox: What I have learned in your course is that federal income tax is extraordinarily complicated; and when I go into business I’ll be sure to hire someone who knows what he’s doing in this area.”
Sadly, I had to fail him. But after all that he did graduate from Harvard Business School, and undoubtedly with that kind of creativity and knack for delegation, he’s become a success in business. He’s probably one of your clients.
I want to thank Roger LeMaster, the executive director of TCPI, and Doug Bates, the chairman of the TCPI Board, for putting together this forum every year. This is an excellent opportunity for tax practitioners, independent tax advisors, and other professionals to get together and to focus on the most important issues in the industry.
As you might imagine, I work closely with Mark Everson, the Commissioner of Internal Revenue, on accounting and financial reporting issues. And our professional staff at the SEC routinely work with IRS staff on a variety of matters that can have a direct bearing on the work that you do.
The SEC is also working with the Financial Accounting Standards Board on the financial reporting of income taxes. We exchange views on disclosures regarding income taxes, and on the manner of reporting transactions that have a particular impact on corporate income taxes. Our Division of Corporation Finance is in an ongoing dialogue with the IRS to determine the best ways to share information.
And, of course, we also have direct oversight of the Public Company Accounting Oversight Board. We fully appreciate that the work we do with the PCAOB, especially with regard to the 404 requirements of Sarbanes-Oxley, has a direct impact on your professional lives.
A large percentage of the material weaknesses discovered during the Section 404 audits of internal controls are linked to accounting for the provision of income taxes. Close to a third of the companies that have reported material weaknesses in their internal controls have determined that at least one of their weaknesses is related to income taxes. Only revenue recognition is responsible for more material weaknesses.
The burden of dealing with income tax related material weaknesses falls disproportionately on small and medium-sized companies. Around 80% of the companies with these problems had under $500 million in revenues. Incidentally, in terms of all material weaknesses, we also see the same imbalance. Most of the companies with material weaknesses, of any type, were also under the $500 million level in revenues.
I recently reviewed the data from SEC filings through December 31, 2005, and found that a few common causes are responsible for the majority of these material weaknesses. The most likely cause is an inadequate application of GAAP for income taxes, such as FAS 109.
The next likeliest is inadequate documentation to support the amounts recorded for such things as valuation allowances and foreign subsidiaries. Other causes are inadequate controls on calculations and reconciliations, and inadequate policies and procedures to review complex or non-routine transactions.
Not surprisingly, our own anecdotal information is that many of the companies that report material weaknesses (again, especially the smaller ones) are relying on their outside auditors to help them cut through the thicket of complexity, because they lack the necessary in-house expertise to be comfortable without that outside advice.
That’s why it’s so important that we’re having this dialogue today. If the SEC is going to be able to address problems with our regime of standards for internal controls, we’ve got to listen and learn from all of you. The SEC and the PCAOB must be always willing to improve our approach to the question of internal controls, to take account of what has worked —and also what hasn’t.
To the extent that this bears on a company’s ability to account for income taxes, the federal government has another reason to insure that things work smoothly. After all, Uncle Sam wants to be to collect all the taxes that are legitimately owed, and it would be self-defeating to make it even harder for companies to pay taxes and report on them properly.
So we want to make sure that the rules we have put in place do indeed encourage people to improve their internal controls—and make financial reporting more useful for the people who rely on financial reports.
What we’re after is quality and results, not bureaucracy. It should be the furthest thing from our minds to encourage a “check-the-box” approach, where a company’s compliance officers simply try to figure out what’s the least they can get away with.
Yes, there are costs associated with the internal controls attestations of Sarbanes-Oxley. As former Chairman Bill McDonough pointed out in late November in his final PCAOB report, “The issuers and the auditors both had quite a difficult time with 404 in the first year.”
But it’s important to add that neither Bill nor I think that this is all merely the SOX-404 version of “Wait Till Next Year.” I know you’re all aware of the survey results reported by the Big Four accounting firms, indicating that larger public companies will see their 404 compliance costs drop by over 40% this year. For our part, we’ll work to see to it that investors increasingly get better value for their regulatory dollars.
Of course, it’s important to remember that Sarbanes-Oxley’s other substantial provisions have already resulted in improvements in high-level attention to disclosure by CEOs, CFOs, and boards of directors. We’ve now got more frequent disclosure by public companies. For the first time, we have independent regulation of the accounting profession by the PCAOB.
Sarbanes Oxley also gave the SEC stronger enforcement tools, as well as the ability to get money to injured investors without their having to hire lawyers and endure lawsuits, thanks to the new “Fair Funds” provisions. Investors benefit from all of these improvements.
There’s one more area where investors will benefit from the lessons learned in the Enron debacle, from which Sarbanes-Oxley was born. One of the ways that the Enron culprits were able to camouflage their schemes was by taking advantage of the sheer complexity of accounting rules—a subject Bob Herz of the FASB might very well discuss later when he makes his presentation.
Both the SEC and the FASB have joined together in a war on complexity; and you should know when you listen to him that Bob Herz and I are singing from the same song sheet. For its part, the FASB is working to codify the existing literature, in order to establish a single source for all GAAP materials.
Together, we’re working to rein in the number of accounting pronouncements that are made by different sources. The SEC staff also supports the primary objective of the FASB’s project on Uncertain Tax Positions. As you know, the point of this is to reduce the excessive variation in the manner that companies account for uncertain tax positions.
I’m sure you’re all aware that our review staff at the SEC frequently comment on the federal income tax consequences of mergers and acquisitions. This isn’t an area of recent focus—it follows from long standing SEC disclosure requirements.
Staff comments in this area request disclosure of the tax consequences of a transaction, and our aim is to see to it that the readers of this SEC mandated disclosure don’t need a tax professional to help them understand it.
It isn’t the SEC’s role to judge whether a company has determined the correct tax treatment (although if we had any serious concerns about that, we would, of course, seek the expert advice of the IRS). But it is our job to ensure that the description of that tax treatment is in plain English.
I’ve been carrying forward the initiative of our former Chairman, Arthur Levitt, to require plain English in accounting and in all of the disclosure mandated by the SEC. We recently proposed new rules to require proxy statements be written in plain English.
As more and more millions of Americans come to depend on securities investments for their children’s educations, their health care, and their retirements, we’ve got to make sure that they have information that is accessible, easy to use and accurate. Eliminating needless complexity will help on all three fronts.
Let me conclude by describing one other initiative that should also help us battle complexity. Interactive data will make financial statements easily searchable and permit almost anyone to slice and dice the data as they see fit.
You may have heard it referred to as XBRL – which sounds like the successor to the Space Shuttle. All that we’re talking about with interactive data, or XBRL, is a way to make financial information much more useful.
It will help investors make better decisions. And it will help you and your clients manage complex business enterprises more effectively, by providing real time financial reports through XBRL feeds.
Bringing financial statements into the 21st century and making them interactive could be particularly useful in evaluating the tax treatment of complex transactions—and evaluating the consequences of alternative treatments. Just as with plain English, promoting the use of interactive data is an important way that the SEC is striving to reduce complexity for investors in a complex world.
It’s been a privilege to join you and to share some thoughts with you as we tackle the twin challenges of investor protection and economic growth. These are noble aims, and they’re complementary. Investor protection isn’t free, but the healthy capital markets and investor confidence that are the necessary ingredients of economic growth depend on it.
As tax and financial professionals, your roles are vitally important to the continued success of our nation in creating jobs, and producing the wealth upon which not only millions of Americans but much of the world depends. Thank you for your dedication to your vocation, and thank you for participating in this forum. The SEC is proud to be your partner.