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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
EU-U.S. Dialogue on Financial Market Regulation — A U.S. Perspective


Commissioner Cynthia A. Glassman

U.S. Securities and Exchange Commission

Annual Washington Conference of the Institute of International Bankers
Washington DC
March 14, 2005

Thank you. I am pleased to have the opportunity to come back to speak to this group again this year. You have asked me to address the EU-U.S. Dialogue on financial market regulation from the U.S. perspective. As you are aware, the Dialogue was created in 2002 as a forum in which to discuss issues surrounding cross-border regulation — the conflicts as well as the common goals. Before going any further, however, I need to give the Commission’s standard disclaimer that the views I express here today are my own and do not necessarily represent the views of the Commission or its staff.

The Dialogue is led by the U.S. Treasury Department and includes the SEC and the Federal Reserve Board on the U.S. side, and representatives of the European Commission’s Internal Market on the EU side. Although the EU-U.S. Dialogue began before the Sarbanes-Oxley Act was signed into law on July 30, 2002, the implementation of the Act added new significance to its purpose. As such, I think the best way to address the EU-U.S. Dialogue from a U.S. perspective is in the context of the Commission’s implementation of Sarbanes-Oxley, including the accommodations we made for our foreign issuers, many of which resulted from this important discussion. I will start with an overview of the general themes or goals of Sarbanes-Oxley, or SOx, and then discuss the concerns and accommodations relating to foreign issuers. I will also highlight other important initiatives currently under discussion within the Dialogue.

As you are well aware, the corporate scandals specific to the U.S. — Enron, WorldCom, HealthSouth and others — prompted the enactment of SOx. The U.S. securities laws and our corporate governance approach are based upon disclosure. Investors and the markets should have access to an appropriate body of information — including transparent and accurate financial statements — on which to judge and compare corporate investments. When that disclosure is false or misleading, or information is omitted so as to present a distorted picture of the truth, investors understandably will lose trust in the companies and the executives who manage them. That is the state in which we found ourselves upon the emergence of the corporate scandals.

SOx can generally be broken down into five major goals or themes, and I will discuss each in turn. The first is restoring confidence in the accounting profession. SOx created the Public Company Accounting Oversight Board. As you know, any audit firm that prepares, or participates in the preparation, of an audit report that is filed with the SEC must register with the Board. The Commission oversees the PCAOB — we appoint the Board, review and approve its rules, and approve its budget. Another reform included within this theme is the amendment of our rules relating to auditor independence. We clarified additional relationships that impair the independence of outside auditors, as well as specified mandatory audit partner rotation requirements.

A second goal is improving the “tone at the top,” that is, reforms meant to set the proper example and culture of management and other insiders at the company. This theme includes our rules requiring disclosure of whether companies have adopted a code of ethics for CEOs, CFOs and other senior financial personnel. These rules also require disclosure of material changes to, or waivers from, the code, and whether a “financial expert” serves on the company’s audit committee. The “tone at the top” reforms also include the prohibition on loans by companies to insiders.

A third goal focuses on reforms designed to improve disclosure and financial reporting. These reforms include our rules relating to the conditions for use of non-GAAP financial measures, as well as the requirement that the SEC review the periodic reports of each public company registered with us at least once every three years. This theme also includes the internal control requirements under 404, which I will discuss in more detail in a few moments.

The fourth goal is improving the performance of “gatekeepers,” or those who advise or analyze public companies. Under this goal, we adopted rules requiring our national securities exchanges and national securities associations, or Nasdaq, to prohibit the listing of any security of an issuer that is not in compliance with the audit committee requirements mandated by SOx, including the requirement that a completely independent audit committee be directly responsible for appointing and overseeing the outside auditors. We also adopted rules regarding the standards of conduct for attorneys practicing before the Commission, including a requirement to report “up the ladder” any evidence of material violations of the securities laws or breaches of fiduciary duties.

The fifth and final goal of SOx is to enhance the Commission’s enforcement tools. As a result of SOx, the SEC now has the ability to establish “Fair Funds” in our enforcement actions so that civil penalties levied against companies can be returned to harmed shareholders, in addition to any disgorgement that is ordered. The Commission has certainly made use of this new tool — since July 2002, we have authorized an aggregate of over $4.5 billion in disgorgement and penalties to be placed in Fair Funds for return to shareholders. In addition, SOx allowed the SEC to freeze temporarily certain extraordinary payments to be made to alleged securities law violators during the course of an investigation.

As the Commission began to implement Sarbanes-Oxley, it quickly became clear that, in some cases, implementing the Congressionally-mandated provisions of SOx could conflict directly with the laws and regulations in other jurisdictions — one size would not fit all. We received insightful comment letters from the foreign community, and we held public roundtable discussions in an effort to fully understand and devise solutions to these conflicts. A key factor in this process was the EU-U.S. Dialogue. Through our interactions with representatives of the European Commission, as well as through our contacts with representatives in other countries, we learned where the potential conflicts lay, while the European Commission learned the objectives of our proposed rules. We also learned how foreign markets and their market participants are regulated so that we could understand how the objectives of SOx might be achieved in other jurisdictions, using very different legal systems. These discussions led us to incorporate accommodations into our proposed rules that avoided putting foreign issuers in the unenviable position of being asked to comply with conflicting laws, wasting management time, resources and intellectual capital as a result.

For example, foreign audit firms were provided an additional six months — that was ultimately extended another 90 days — to register with the PCAOB. We also approved rules relating to the PCAOB’s required inspection and investigation of foreign audit firms. These rules allow the PCAOB to rely, in varying degree, upon the inspection and investigative regimes of the firm’s home country. With respect to the prohibition on loans to company insiders, we adopted rules providing an exemption for certain foreign banks that is comparable to the exemption provided under SOx to U.S. banks. In our final rules relating to audit committee financial experts, we clarified that an audit committee financial expert could gain his or her expertise by demonstrating an understanding of an issuer’s home country GAAP, rather than an understanding based solely on U.S. GAAP.

With respect to our rules relating to non-GAAP measures, we provided a safe harbor for disclosures of non-GAAP financial measures made outside of the U.S. In addition, we approved final audit committee listing standards that allow non-management employees to serve as audit committee members, consistent with “co-determination” and similar requirements in some countries, such as Germany. We also permitted alternative structures — such as statutory auditors or boards of auditors — where these structures are provided for under local law. And finally, our rules regarding attorneys appearing or practicing before the Commission exclude “non-appearing foreign attorneys,” defined generally as attorneys who do not hold themselves out as practicing or giving legal advice concerning U.S. securities laws.

Despite these accommodations, over the past six months or so, I have increasingly seen and heard commentary assessing the costs and benefits of SOx, both from the foreign as well as U.S. perspective. What I have heard overall is generally positive, except for 404. While it may be too early to know for sure, or to have the empirical data to support the view, I do perceive an increase in investor trust and confidence in company financial statements and management. There is no question regarding the increased compliance burden, but the alternative — business as usual — was not an option.

Nevertheless, I am deeply concerned when I hear that some foreign issuers may desire to forego registering with, or desire to de-register from, the SEC in order to avoid the compliance burdens associated with Sarbanes-Oxley, specifically the internal control burdens. As a free market economist, I believe issuers should be able to enter and exit markets as they deem appropriate, based upon efficiency and other competitive concerns. In this respect, we are considering revising our de-registration requirements, an initiative I strongly support, with the one caveat that the resulting standards must continue to support the SEC’s mission of investor protection. Having said that, I do believe the internal control provisions, which appear to be driving the firms’ de-registration concerns, are a well-intentioned means of restoring trust in financial reporting — if, and this is an important if, they are implemented reasonably.

I want to spend just a couple of minutes on 404, the provision of SOx that I believe is the greatest concern for our foreign issuers. As you know all too well, Section 404 is the disclosure provision that requires management to assess and publicly report on the effectiveness of their internal controls. In addition, under the rules, auditors must publicly provide an opinion on management’s assessment, as well as a separate opinion on the effectiveness of the internal controls. In the U.S., we have already begun to receive company 404 reports and opinions, and tomorrow, March 15th, marks the deadline by which we will receive, from our calendar-year-end companies, the majority of the first 404 reports. I have heard from our domestic issuers that the demands of 404 have caused companies and auditors to put business initiatives on hold — product launches and hiring deferred, IT-system installations postponed, and strategic alliances delayed. Basically, the criticism is that 404 compliance has taken management’s attention away from running the business of the company.

I have no doubt that foreign companies are facing similar concerns, all of which are compounded by the required adoption of International Financial Reporting Standards, or IFRS, earlier this year. The Commission has already taken steps to provide foreign issuers with more time and greater flexibility in complying with the rules, and we are also starting the process of determining how to improve them.

  • We initially extended the compliance date for our foreign issuers from April 15, 2005 to July 15, 2005 and, as I am sure you are all aware, we recently further extended the compliance date to July 15, 2006.
  • We allow foreign issuers to use foreign frameworks, such as the Turnbull Report published by the Institute of Chartered Accountants in England and Wales, for evaluating their internal controls.
  • We will be holding a public roundtable on 404 implementation on April 13th, and we are soliciting, and have already started to receive, written feedback regarding the experiences of issuers, auditors and others in implementing the new internal control requirements.

I strongly encouraged the public roundtable, because we need to hear directly from those “in the trenches,” throughout all phases of the implementation process, so that we can best determine how the process can be improved to reduce the burden, without reducing the benefits. Ultimately, we need to ensure that companies are improving and monitoring the internal controls that materially affect the financial statements, and that auditors have the guidance they need to appropriately set the scope of the testing and audit of management’s assessment and the internal controls themselves. Key issues are what is material and what is the appropriate scope of testing. I am hopeful that the roundtable and public comment period will provide us with the helpful guidance we need.

I now want to return to the EU-U.S. Dialogue and briefly mention a couple other issues that are an important focus of the Dialogue. Just as our foreign counterparts have been willing to work with us in avoiding conflicts resulting from new regulations, we must be willing to work with them. A good example of this coordination has been the EU Financial Conglomerates Directive, and the related SEC Consolidated Supervised Entity rules.

I won’t go into detail regarding these rules, but their purpose is to ensure that holding companies of global financial conglomerates are subject to similar supervision, regardless of whether the primary regulator is in the U.S., or the EU. While I know there remain issues to be discussed surrounding this initiative, I have every expectation that the implementation of the EU’s Directive, and the Commission’s consolidated supervision rules, will prove to be a step forward for efficient, yet fair, regulation, to the benefit of investors and the markets.

A second issue which has been raised by the EU is whether, and when, the Commission will no longer require financial statements prepared according to IFRS to be reconciled to U.S. GAAP. This issue has grown in urgency recently due to the fact that, as I mentioned earlier, most EU public companies were required to adopt IFRS earlier this year. The Commission has proposed changes to our rules to allow first-time users of IFRS to reconcile their financial statements to U.S. GAAP for only two years, and I am hopeful that we will adopt this proposal soon. I realize that this is only a first step, but I believe it is an important first step as we continue to discuss the issues and lay the groundwork for no longer requiring reconciliation. Obviously, what could completely eliminate the need for reconciliation is convergence of IFRS and U.S. GAAP, another topic of discussion in the Dialogue and one I fully support. True convergence would enhance financial statement transparency, allow investors and other market participants to compare companies across borders, and assist regulators in carrying out their oversight.

In conclusion, through the Dialogue, we have discovered that the U.S. Securities and Exchange Commission and the European Commission are confronted with many of the same regulatory issues, as emphasized by the similar financial scandals in both our markets. As we have considered whether to introduce new regulation, or to strengthen existing regulation and enforcement, the Dialogue has proven to be an effective forum for exploring new ideas and approaches, while at the same time allowing us to avoid unnecessary regulatory conflicts. After all, the EU and U.S. share the same fundamental goals in regulating the securities markets — protecting investors and maintaining integrity in our markets — and ultimately, we all operate in the same global market.

Thank you, and I am happy to answer any questions that you may have.



Modified: 03/14/2005