Speech by SEC Staff:
Remarks before the Practising Law Institute
Fifth Annual Institute on Securities Regulation in Europe
Alan L. Beller
Director,Division of Corporation Finance
U.S. Securities and Exchange Commission
December 5, 2005
I am pleased to have the opportunity to open this year's Annual Institute on Securities Regulation in Europe. This is the third year that I have had the privilege of participating in this program, and I'd like to recognize some of the people who have worked so hard on this program to make it a success. First, our co-Chairs. Ed Greene and Pat Kenajian have been heading up this program for a number of years now, and this year they are joined by Richard Morrissey. On behalf of the co-Chairs and other participants, I'd also like to thank the folks at PLI who, as always, have contributed to the success of this program.
This would be a good time to point out that, as a matter of policy, the SEC disclaims responsibility for remarks by the members of its staff. Therefore my remarks represent my own views and not necessarily those of the Commission or other members of the staff.
Next month will mark my fourth anniversary at the Commission. A lot of things have changed since I left private practice. I was named head of the Division of Corporation Finance just two months after the attacks on the World Trade Center, one month after Enron's financial problems first came to public light, and one month before Enron filed for bankruptcy. The first six months of my time at the Commission also saw the uncovering of the fraud at WorldCom and other large companies and the enactment of the Sarbanes-Oxley Act.
So to say that during the last four years the regulatory landscape in the United States has changed dramatically is an understatement - with more attention turned to disclosure certification, disclosure controls and that headline-grabber, internal control over financial reporting. Developments in similar areas, albeit sometimes in different packages, have taken place in other jurisdictions, as regulators and markets, particularly on both sides of the Atlantic, have sought to address the scandals and excesses of the market bubble.
While there have been increased requirements, there have also been moves to regulatory streamlining and efficiency. Chief among these in the corporate area in the United States has been Securities Offering Reform, which became effective just last week and provides the promise of liberalized communications and a capital formation process with fewer unnecessary regulatory obstacles. Also last week, the Commission proposed for comment new rules that would permit electronic delivery of proxy materials. While the proxy proposal does not affect foreign private issuers, Securities Offering Reform could have profound positive impacts for those issuers, which I will discuss in a few minutes.
At the same time, there have been very substantial changes in the European regulatory landscape. The Financial Services Action Plan, the Prospectus Directive and the follow-on steps at the European and national level bring the promise of a single integrated European market. The work of the IASB and the European Commission brings the promise of a single set of European accounting standards. And the Eighth Company Directive brings the promise of a more harmonized European approach to regulation and oversight of auditors and audits.
One regulatory constant is that the actions of regulators can have a significant effect in global markets. And I believe that one of the positive developments of the last few years, engendered both by the exceptional level of regulatory activity and by the growing recognition of the potential global impact of regulation, has been the increased coordination between regulators across borders (particularly between the United States and Europe) and the recognition on both sides that, while disagreements may exist, it is nonetheless important to avoid surprises.
Another lesson is apparent. The principles of free movement of capital and freedom of choice of investors, combined with advances in communications and information technology, have allowed cross-border and global investment to grow enormously. According to recent Federal Reserve statistics that Ed Greene has called to my attention, from 1995 to 2004, total non-mutual fund holdings of non-U.S. investors in U.S. equities grew from $550 billion to approximately $2.1 trillion, and during the same period total non-mutual fund holdings of U.S. investors in non-U.S. equities grew from $790 billion to approximately $2.5 trillion. Regulations and regulators should facilitate that very positive development. They should not, and indeed in many respects cannot, stand in its way.
There is ongoing criticism of regulators generally, including the Commission, that we do not do enough to facilitate global markets and investment. Indeed, in some sense and in some circles we can never do "enough." I would submit that we have actually done quite a bit. In the "first do no harm" category, I would suggest that in perhaps the largest challenge that the Commission faced in my tenure, the implementation of Sarbanes-Oxley, the Commission has been very sensitive to the concerns of non-U.S. issuers. In areas involving disclosure, the Commission has historically called for similar regulation, and has continued that approach. But in areas involving internal corporate workings, such as audit committee listing standards and insider loans by foreign banks, the Commission has been appropriately flexible.
In areas of overlapping regulation or supervision, for example in the case of auditors, the Commission and the PCAOB and their European counterparts have worked diligently and cooperatively.
In order to support the very important 2005 adoption of IFRS mandated by the EU for European listed companies, we delayed for one year the implementation of internal control assessment and audit requirements under Section 404 of Sarbanes-Oxley, and we provided an accommodation to our reporting requirements which eliminated the need for European companies to provide a year of IFRS financial statements that was not called for by European requirements.
I do not intend to dwell this morning on the internal control assessment, reporting and audit requirements, but I can assure you that both the Commission and the PCAOB continue to monitor the expense of the exercise, particularly for smaller companies, and to seek approaches and solutions that assure efficiency while obtaining the benefits of better attention to internal control over financial reporting.
There are three additional areas that I would like to address this morning where I think the Commission's actions and possible actions are in the "sweet spot" of responsibly facilitating global investment activity: foreign deregistration; the roadmap for consideration of acceptance of IFRS as a primary system of accounting without requiring reconciliation to U.S. GAAP; and securities offering reform.
As to deregistration, there have been predictions that there would be a rush of companies - both U.S. and non-U.S. - to deregister in the wake of Sarbanes-Oxley. This does not appear to have been the case, although some companies have done so, others have apparently foregone or delayed decisions to go public in the United States, and acquisition may have become an alternative strategy for some companies. The unexpectedly high costs of compliance with the internal control assessment, reporting and audit requirements have caused continuing focus on this point.
At the same time the Commission and its staff have been considering the rules governing whether and how a foreign private issuer may exit the U.S. registration and reporting system. And we have been listening to concerns raised, including by European companies and associations, about those rules. Specifically, we have heard that, while it is relatively easy to delist from a U.S. market, the process to deregister and terminate the filing obligation with the SEC is difficult and in some instances impossible. The Commission has noticed an open meeting on December 14 at which it will consider a recommendation from the Division of Corporation Finance to propose rules changes regarding deregistration.
First, the maximum number of 300 U.S. resident shareholders permitted to deregister may be out of date in light of the ongoing globalization of the securities markets. The threshold was established several decades ago when there was much less cross-border ownership of securities. The number of foreign companies with Exchange Act reporting obligations increased from approximately 300 in 1985 to over 1,200 in 2004. In that same period, foreign private issuers increased from approximately 3.5% of NYSE-listed companies to over 16%.
Although I do not know where the Commission ultimately will come out on any changes to the rules, ideas to modernize the threshold for deregistration include a test based on percentage U.S. ownership rather than number of owners and a test that would distinguish between large and small companies. The second idea would recognize that large companies are more likely to have a larger percentage of their shares held by U.S. residents and that broader U.S. and international following of large companies by analysts and institutional investors provides alternative sources of information and market attention for these companies.
Also in this area, while again I cannot speak for the Commission, I would repeat what I have said previously, that I would not recommend using trading volume by itself as a test for deregistration. I believe such a standard could fail to take sufficient account of U.S. investor interest and thus would inadequately address investor protection concerns. However, I also believe that a dual standard involving both a trading volume test and a U.S. percentage ownership test is an idea worth considering.
A second area that may be ripe for reexamination is the counting method that foreign issuers must use under the current deregistration rules. Under the current method - which dates back more than 40 years to a time when book entry systems were in their infancy and street name holdings far less prevalent - issuers must "look through" street name brokers and custodians, on a worldwide basis, to determine whether shareholders are U.S. residents. Today, where securities are held through various book-entry systems around the world, this system can be extremely burdensome.
Since these rules were adopted in the 1960s, the Commission has adopted different counting rules in other cross-border contexts, particularly in the areas of cross-border tender offers and exchange offers. While there have also been criticisms about these rules, it is generally agreed that they provide a more workable approach in that they require a foreign private issuer to look through nominees only in the United States and its home jurisdiction (and, if different, its principal market). The Commission could consider such an approach in the deregistration area as well.
Third, under current rules even after a foreign company has ceased reporting, it is possible for it once again to become subject to SEC reporting requirements. The Commission could consider whether the termination of registration requirements should be permanent, assuming no future offering or listing activities triggering new registration requirements.
Finally, the Commission could consider whether there should be an easier and more effective process than exists today to make the Rule 12g3-2(b) exception available to foreign private issuers who deregister and to make the resulting information better available to investors.
To turn to my second topic, an even more important area for global markets involves the adoption of IFRS as the single accounting standard in the EU, starting with the reporting requirements for 2005 for European listed companies, and the status of the so-called "roadmap" by which the Commission could consider accepting IFRS as a primary system of accounting without requiring reconciliation to U.S. GAAP.
Nothing, and I repeat, nothing, could be more important to global markets than having only one or two widely used and accepted sets of accounting standards.
So where are we now in contemplating the reconciliation requirement? For the most comprehensive recent answer to that question, I would refer you to a speech that the head of the Commission's Office of International Affairs, Ethiopis Tafara, standing in for Chairman Cox, delivered last week before the Federation of European Accountants in Brussels.
For my part, I would summarize where we are as follows:
- While Don Nicolaisen, the Commission's former Chief Accountant and the principal cartographer of the roadmap, has left the Commission, he left a copy of the roadmap behind. And, even more importantly, he has left behind people who share his view of the tremendous importance of the opportunity that IFRS represents. The Commission staff is currently at work building on the roadmap. Some of the conditions precedent are clear - independence of the standard setters, continued high quality standards that serve the interests of investors, continued dialogue and progress among regulators on both sides of the Atlantic. It would be unfortunate if, while the SEC were embarked on a process to determine whether and how U.S. GAAP and IFRS can co-exist in the United States, the European Commission was determining that they cannot co-exist in Europe or were introducing significant additional disclosure requirements.
- Convergence is important. Over the last three years the convergence process has reduced differences between U.S. GAAP and IFRS, and at the same time improved both. A continuing robust program of convergence must continue. But the elimination of the reconciliation requirement by the Commission does not in my view depend on any particular degree of convergence. What is required to eliminate the reconciliation requirement is a rigorously applied system of IFRS that U.S. investors are able to understand, even if there are substantive differences between IFRS and U.S. GAAP.
- The IASB has done yeoman work in creating a high quality system of accounting principles in a very short period of time. However, IFRS is a high quality system that has existed in near its present form for only a few years. It is now widely used. How will it be interpreted and tested? Will application and interpretation be uniform?
- The importance of these questions means that attention in implementing IFRS now moves away from the IASB to issuers, accounting firms, lawyers and regulators. Several thousand companies will file financial statements under IFRS in Europe for 2005, and several hundred of them will also file with the Commission under IFRS. European regulators and the Commission staff will both be looking at those filings. To the extent that issues of serious divergence with U.S. GAAP are identified, Commission staff would certainly alert the IASB and the FASB regarding convergence issues. But I expect that the primary focus of the review on both sides of the Atlantic will be on the consistency, effectiveness and transparency of reporting under IFRS.
- Issuers, accounting firms and regulators on both sides of the Atlantic all bear a responsibility for seeing that IFRS meets these standards. The prizes are too great not to succeed. A single set of standards for European issuers that will help integrate European markets and lower the cost of capital. And the ability to reach the destination plotted on the roadmap - for European issuers to list and raise capital in the U.S. markets without a U.S. GAAP reconciliation requirement.
To turn to my third topic, the Commission this year adopted reforms to our registration system and offering rules under the Securities Act of 1933 that represent the most far-reaching changes to the offering process in more than 20 years, since the adoption of shelf registration. Those rules, which just became effective on December 1, substantially relax restrictions on communications, especially written communications, in registered offerings and substantially streamline and update the registration process, particularly for the largest issuers, known under the rules as well-known seasoned issuers. Overall, these reforms will significantly enhance access to and communications in the U.S. market for non-U.S. issuers that choose to avail themselves of the new rules.
Automatic shelf registration for well-known seasoned issuers provides instant access to U.S. public markets and nearly complete flexibility in disclosure mechanics. Registration statements are immediately effective and not subject to Commission review prior to effectiveness. Almost all disclosure can be included in prospectus supplements or Exchange Act filings rather than base prospectuses. Fees can be paid at the time of filing, in advance or on a pay-as-you-go basis.
Importantly, all of the advantages of automatic shelf registration are fully available to foreign private issuers that file annual reports on Form 20-F or 10-K. To qualify as a well-known seasoned issuer, a company must be eligible to file on Form S-3 or F-3, and have at least $700 million in worldwide public float of common equity or have issued within the preceding 3 years $1 billion in non-convertible, non-equity, securities in a registered offering for cash. It also must not be an ineligible issuer.
The new rules also allow more information to reach investors. Until December 1st written offers in registered offerings in the United States, other than the statutory prospectus, were generally illegal "gun-jumping". The reforms provide that a variety of ordinary course communications by companies can continue through the offering process. The reforms also introduce a powerful new concept in the free-writing prospectus - a written offer that is not a statutory prospectus. These written offers are now legal, subject to certain conditions, and now will be evaluated for the material accuracy and completeness of their disclosure, rather than prohibited.
Well-known seasoned issuers, U.S. and foreign private issuers alike, may engage at any time in oral and written communications, including the use of free-writing prospectuses. Other companies can use this new concept after filing a registration statement.
There has been much focus by attorneys and underwriters on disclosure liability concerns surrounding the use of free writing prospectuses. Just as with the introduction of any other new and far-reaching concept, it can be expected that initially market participants will proceed cautiously. Nonetheless, I believe that free writing prospectuses will over time be recognized as a powerful tool in the offering process as market participants come to see their potential and flexibility. I also believe that the "just say no" attitude to free-writing prospectuses currently adopted in some quarters will break down over time.
The bedrock of the Commission's securities offering reform is the strength of our periodic reporting system. The Commission's decision to increase the flexibility of the registration system for all issuers and to allow the largest companies to access the market instantly depended on the enhancements to periodic and current reporting and disclosure processes under the Exchange Act.
While I have covered a number of topics this morning I hope that the overall theme of my remarks is clear - that in our increasingly global markets the global coordination of regulation has never been more important. Conferences such as this are so valuable because they can contribute to such coordination.
Thank you again for inviting me to be here today with you.