Speech by SEC Staff:
Regulation in a Global Environment
Alan L. Beller
Director, Division of Corporation Finance
U.S. Securities and Exchange Commission
American Academy in Berlin
April 20, 2004
I am very pleased to have the opportunity to speak to you tonight about securities regulation in the global environment. The Securities and Exchange Commission and its staff must be ever-conscious of the global implications of our activities.
This would be a good place to point out that as a matter of policy, the SEC disclaims responsibility for remarks by the members of its staff, and therefore my remarks this evening represent my own views and not necessarily those of the Commission or other members of the staff.
I should also add that long before I joined the SEC I had interest in and experience with global regulation. I spent 25 years in private practice for a large international law firm, stationed not only in the United States both also for seven years in Europe and Japan. So I have seen first-hand how the regulations of various countries can affect companies and global markets.
Because of the breadth of securities regulation and because of my own responsibilities as Director of the SEC's Division of Corporation Finance, which focuses on regulation of companies that make public offerings or are listed in the United States, I propose to focus my remarks on this aspect of global regulation. This approach will give us plenty to talk about, but will leave for another forum or another day a number of important subjects, such as auditor oversight, consolidated supervision of financial institutions and regulation of cross-border market access by foreign exchanges.
In my experience with international securities issues, I have never seen a time when the discussion of the need for a global approach to regulation has been more active. There are many reasons for this. Investment has become a more global exercise in almost all developed markets, though the degree of foreign investment may vary from market to market. Developments in technology and communications make national borders increasingly unimportant to the transmission of information and the conduct of transactions. Both cross-border securities offerings and cross-border acquisition transactions have increased markedly in recent years. For example, during the 1990s announced cross-border acquisitions involving U.S. companies increased more than four-fold - from approximately 500 in 1990 to approximately 2400 in 1999.1 During that same decade, the total dollar amount of cross-border securities holdings where non-U.S. investors held U.S. securities, or vice versa, grew from approximately $1.5 trillion to approximately $6.9 trillion.2 Currently, there are approximately 1250 non-U.S. companies registered and reporting with the SEC - that is an increase from fewer than 400 at the beginning of the 1990s.
To these often cited reasons for interest in a coordinated global regulatory approach I would add two others. First, there is global recognition of the massive financial and accounting frauds and shortcomings in corporate governance, from Enron to Parmalat. However, while these events have now rolled across borders and oceans, the responses to them to date have been largely national.
Second, the continuing development of the EU in a number of respects, in particular its increasing prominence in the regulation of financial markets, financial institutions and public offerings and listings, has made it essential for national regulators in Europe and for other regulators around the world, including the SEC in the United States, to take a global view of regulation. Two examples are the EU's Financial Services Action Plan, which is being implemented, and the 8th Company Law Directive, which includes requirements for independent audit committees, auditor rotation and oversight of the audit profession, among other things.
I think that most of us would agree that globalization of financial markets is a positive development. The increased and more diverse flows of capital make all of our markets more liquid and resilient. But harmonizing regulatory approaches to global markets presents many challenges. Even jurisdictions that share a commitment to free and open markets can have vastly different regulatory systems - different legal systems, market structures, economic systems and regulatory philosophies make for very diverse systems of regulation.
U.S. Regulation of Issuers
Before discussing what I view for the future of global regulation, I thought it would be helpful to give some brief background into the regulation of the securities markets in the U.S. generally, as well as to discuss the U.S. approach to the regulation of non-U.S. issuers.
Until the 1930s, the securities markets in the United States were regulated only by the individual states and the stock exchanges. (In modern terminology the stock exchanges and the newer NASD and Nasdaq are referred to as self-regulatory organizations or SROs.) In the wake of the market crash of 1929, Congress created a federal securities regulatory system, including the SEC, which was established in 1934.
The federal securities laws that the SEC administers focus primarily, although not exclusively, on the regulation of disclosure, the proxy process for shareholders meetings, accounting and auditing. In our federal system, corporate governance matters are still largely left to the states. The State of Delaware has the most settled body of corporate law, and most large public U.S. companies are incorporated in Delaware.
In other respects, the SEC plays a dominant role in setting or overseeing standards for the U.S. markets and for enforcing them, even where there is involvement of a number of other actors.
For example, the stock exchanges and the Nasdaq also significantly influence corporate governance through their listing standards. The requirements established in late 2003 for majority-independent boards of directors and independent committees are embodied in stock exchange and Nasdaq listing standards. However, the SEC has direct oversight responsibility for the exchanges and other SROs, including through a requirement that all SRO rules and standards are subject to SEC approval.
As another example of the SEC's role, while under the federal securities laws the SEC has authority to set accounting standards for public companies in the U.S., it has looked to an independent, private-sector body - the Financial Accounting Standards Board, or the FASB, to develop accounting principles and standards. The SEC works closely with the FASB in connection with its standard-setting agenda. In addition the FASB does not have enforcement powers so the SEC is the primary enforcer for public company accounting.
And the new Public Company Accounting Oversight Board, or the PCAOB, was created by federal legislation but is a non-governmental body charged with creating and enforcing standards for the audits of public companies. Again, the SEC has direct oversight responsibility for the PCAOB. All of the PCAOB's rules, including the auditing standards it adopts for public company auditors, are subject to SEC approval.
In all of these areas, the SEC's mission is to administer and enforce federal securities laws in order to protect investors and to maintain fair, honest and efficient markets.
The U.S. Approach to Regulation of Non-U.S. Issuers
These dual goals - investor protection and fair and efficient markets - guide the Commission generally, including in its dealings with non-U.S. issuers in the U.S. markets. Therefore, when it considers regulatory actions that might effect non-U.S. issuers, the SEC's primary objectives are:
to ensure that investors have comparable information about companies trading in the U.S. markets - whether those companies be foreign or domestic; and
to keep a level playing field for all market participants.
The approach of the SEC generally has been to treat non-U.S. issuers seeking access to the U.S. markets similarly to U.S. issuers for purposes of the regulation of accounting and disclosure, and to make more accommodations in the areas of corporate governance and corporate processes.
This philosophy results in our requiring similar disclosure to that required of U.S. companies, and requiring the use of U.S. generally accepted accounting principles, or GAAP, as the primary system of accounting for the issuer, or requiring a reconciling to U.S. GAAP. This approach allows the U.S. to fulfill the two goals I mentioned earlier - to provide equivalent information for U.S. investors and to ensure that foreign and domestic companies are operating on equal footing.
To the extent that U.S. federal securities laws vary from this approach, it has been to make accommodations for non-U.S. issuers. The SEC's registration and annual report forms for foreign private issuers are drawn largely from standards developed by the International Organization of Securities Commissions, or IOSCO, and are tailored to take into account existing home country requirements. Foreign private issuers are also given more time to submit annual reports than are U.S. companies. We did not change the deadlines for foreign private issuers when reporting deadlines were accelerated for larger U.S. issuers.
In addition, the interim reporting standards for non-U.S. issuers are different than for U.S. issuers. The SEC allows non-U.S. issuers to provide interim reports based on home country requirements. U.S. issuers are required to file quarterly reports and under recently adopted rules will have more extensive current reporting requirements starting in August 2004. I do not see the SEC in the short term actively considering changing the rules for foreign private issuers despite these changes for U.S. issuers. I do want to return later, however, to discuss the themes of global regulation in the context of the European Parliament's recent decision not to recommend quarterly reporting, as was suggested by the European Commission.
In matters of corporate governance or internal corporate processes, the SEC historically has been sensitive to the need to accommodate foreign structures and requirements. Some examples of the this are of such long standing that people do not think about them anymore - for example, exemptions, which date back to the 1930s from the SEC's proxy rules and from the short-swing profit rules (and companion reporting requirements) related to trades by company insiders. Moreover, aggregate executive compensation disclosure, rather than individual disclosure, is allowed for foreign issuers, if aggregation is permitted by the issuer's home country.
Sarbanes-Oxley Act of 2002
The SEC and non-U.S. issuers and regulators have devoted significant attention since July 2002 to the treatment of non-U.S. issuers under the Sarbanes-Oxley Act of 2002 and the SEC's implementing rules. The Division of Corporation Finance played the principal staff role with regard to the rules related to the disclosure and corporate governance aspects of the Act.
The Sarbanes-Oxley Act, passed overwhelmingly by the U.S. Congress, does not provide an exemption for non-U.S. companies that are registered with the SEC. The SEC and the Division staff have consistently taken the position that the implementing rules must be consistent with both the letter and the spirit of the Act. In addition, however, the SEC has been sensitive to the potential effects of the Act on non-U.S. issuers.
All the rulemaking the SEC is required to do under the Sarbanes-Oxley Act is now complete, although not all of the new rules have yet come into effect. And the PCAOB's setting of audit standards is still in progress.
Although some may disagree, I think the results make clear that the SEC has worked hard to afford appropriate accommodations to non-U.S. companies that are in fact consistent with the letter and spirit of the Act. I would submit that the general principles I discussed earlier were followed in all our Sarbanes-Oxley rulemaking - we focused on providing a level playing field in respect of disclosure provisions and sought to make accommodations with regard to corporate processes where they were appropriate under the Act and necessary to avoid conflicts with processes and practices in foreign jurisdictions. In consideration of possible implementation difficulties, we provided longer transition periods in some rules for non-U.S. issuers in a number of cases.
Our approach to disclosure requirements has raised some questions. For example, some have questioned the application of the certification requirements for Chief Executive Officers and Chief Financial Officers to non-U.S. issuers. I believe strongly that certification and the companion requirement of disclosure controls that was added to the SEC rule are squarely targeted at the quality of disclosure. As such non-U.S. issuers should be treated comparably. The argument that under corporation law different officers or directors have responsibilities that should be taken into account misses the point - under the corporation laws of the various states in the United States there is also no responsibility of the sort imposed by the certification requirements. The requirement is imposed under the Act to enhance the quality of disclosure as a matter of the U.S. federal securities laws, without regard to corporation law standards.
On the other hand, there are a number of examples of accommodations for non-U.S. issuers that the SEC made in its rules implementing the Sarbanes-Oxley Act.
Audit Committees. The Sarbanes-Oxley Act recognized the critical role of the audit committee in serving as a key governor on a company's financial reporting system. The Commission applied the basic Sarbanes-Oxley mandates to both U.S. and non-U.S. issuers, including independence requirements, the responsibility for retention and oversight of external auditors, and the ability to retain outside advisers.
But before the rules were even proposed, the SEC reached out to both non-U.S. issuers and regulators. After listening closely to concerns, the SEC adopted rules regarding audit committees that include accommodations to take into account the corporate governance rules and internal corporate processes in many non-U.S. jurisdictions.
For example, the rules accommodate the "co-determination" and similar requirements in Germany and other jurisdictions by permitting non-management employees to be members of audit committees. Alternative structures, such as statutory auditors permitted in some European jurisdictions and boards of auditors employed in Japan and elsewhere are permitted subject to some conditions. And shareholders are permitted to ratify selection of external auditors as called for in many European jurisdictions.
Internal Control Reporting. The SEC extended the transition period related to internal control reporting for non-U.S. issuers. Disclosure is required in annual reports for foreign private issuers for fiscal years ending on or after July 2005, whereas for larger U.S. companies it is November 2004. Foreign private issuers are also specifically permitted to use frameworks for internal controls developed for issuers outside the United States. Those mentioned as suitable alternatives are the Guidance on Assessing Control published by the Canadian Institute of Chartered Accountants and the Turnbull Report published by the Institute of Chartered Accountants in England and Wales.
Non-GAAP Financial Measures. We have been making a number of comments as a result of the new requirements regarding non-GAAP financial measures, and I expect we will be making comments under the same rules on annual reports of non-U.S. issuers filed with the SEC. There is, however, an exemption for non-US GAAP communications outside the United States, even where those communications reach the United States. The SEC did this because it sought not to interfere with communications in non-U.S. markets and international information flow generally.
Loans to Insiders. Sarbanes-Oxley prohibits loans by companies to their insiders. While the Act provided an exemption for U.S. banks, it did not provide a comparable exemption for non-U.S banks. Just last week, the SEC adopted a rule providing non-U.S. banks with just such an exemption.
While Sarbanes-Oxley has dominated most recent discussions of the SEC's treatment of non-U.S. issues, it is not the only development in this area. For example, in late 2003 the New York Stock Exchange and the Nasdaq adopted listing standards regarding corporate governance in the areas of independent boards, independent nominating and compensation committees, and other matters. (Standards regarding audit committees were mandated by the Sarbanes-Oxley Act.) Because these corporate governance issues relate to internal corporate processes, the new listing standards permit exceptions for foreign issuers, but they do take a new step of requiring disclosure of manner in which foreign issuer departs from listing standards.
The SEC has in place a number of initiatives designed to encourage offerings and listings in the U.S. by non-U.S. issuers. I would be remiss if I came to Berlin and did not encourage any company that may consider a U.S. offering or listing to contact the SEC staff in the Division of Corporation Finance at any stage in their consideration with any questions they might have.
Approach to Global Regulation
I'd like to spend the remaining time in a more general discussion about some future issues and general approaches to regulation in a global environment. In particular, I'd like to share some thoughts regarding disclosure-based approaches to regulation (including the "comply or explain" approach to regulation), the concept of mutual recognition, the concepts of equivalence and convergence (especially in the accounting area) and the interesting topic of interim and current reporting.
A Disclosure-Driven Approach: "Comply or Explain". As discussed above, most of U.S. federal securities regulation of issuers is disclosure-based. Even where substantive matters are addressed, disclosure is most often used as the vehicle to achieve a desired objective, or at least to add transparency to issues worthy of public attention. One example would be executive compensation, where our rules provide extensive disclosure requirements but no substantive prohibitions. More recently, there are comparable examples in the Sarbanes-Oxley Act, such as those mandating disclosure of whether or not a company has adopted a code of ethics with specified objectives or whether or not a company has an audit committee financial expert.
In this vein, despite the concerns that some have expressed that the United States and the SEC are exporting their rules to other countries through the implementation of the Sarbanes-Oxley Act, in fact the scope of the Act in the corporate governance area is relatively limited. It touches on a few areas such as audit committees and loans to insiders. In those areas there has been, as discussed above, some appropriate accommodation to non-U.S. corporate governance standards and corporate processes.
Beyond these limited areas, U.S. regulators and markets have generally not taken action to force non-U.S. issuers into U.S. corporate governance molds. In particular, the corporate governance listing standards adopted by the New York Stock Exchange and the Nasdaq do not impose on non-U.S. issuers the corporate governance requirements imposed on U.S. companies. Instead, for non-U.S. issuers these markets apply a "comply or explain" approach.
It seems to me that this approach has considerable merit for features of corporate governance, with one important caveat. There are some areas where the principles of corporate governance can be so important that optional non-compliance with an explanation should not be permitted. Congress identified an example of that judgment in the United States with the audit committee provisions in the Sarbanes-Oxley Act. The importance of an audit committee with key responsibilities was enshrined in the Act with mandatory listing standards. But in other cases "comply or explain" can be a viable approach well worth considering.
Mutual Recognition. Some market participants and commentators favor a "mutual recognition" approach - an approach whereby companies can comply with the rules of their home country even when doing business in another country.
Such an approach would seem easiest to achieve within the EU, where there is a forum and mechanism to develop common approaches to regulation and thereby to seek equivalence in regulation. Even within the EU, however, mutual recognition presents challenges. Each member state can bring to the table different priorities and perspectives - and perceived national imperatives can be obstacles to operating with an entirely global point of view. And even if the relevant regulators in each country come to an agreement as to a mutually acceptable approach, there is no guarantee that the political climate in each country will permit that approach in all cases.
I believe that the feasibility of mutual recognition rests in large part on equivalence or convergence of general regulatory objectives and requirements, although not necessarily on complete congruence of each specific requirement. It is, in fact, regulatory harmony between U.S. and Canadian disclosure and registration requirements that made the Multi-Jurisdictional Disclosure System, or MJDS, in the U.S. and Canada feasible.
Implicit in my view that basic harmonization or convergence is required before mutual recognition can be seriously considered is the conclusion that, while comity is an important element underlying the desire for mutual recognition, comity is not a sufficient justification for mutual recognition. Some level of harmonization or equivalence in the regulatory framework must also exist. And I would posit that one reason that the EU finds mutual recognition a comfortable approach is that it has the tools to produce a common regulatory framework among the nations within its boundaries, while still permitting differences in specific regulatory requirements. The requisite common regulatory framework exists in fewer cases between the EU and the United States, and in my view mutual recognition is therefore harder to achieve.
Equivalence and Convergence. The key to better coordination of global regulatory approaches are working at convergence and towards equivalence. And there have been signal successes.
One example has been the disclosure framework for issuers in non-home country jurisdictions. A very significant convergence project for disclosure by issuers outside their home jurisdictions was undertaken under the aegis of IOSCO. Following its completion in the 1990s, a number of regulators, including the SEC, modified their regulations. In the SEC's case, it revised its disclosure requirements for non-U.S. issuers by amending its annual report form for foreign private issuers to adopt the IOSCO standards.
The best and most interesting current example of efforts at convergence involves the workings of the U.S. Financial Accounting Standards Board, or FASB, and the International Accounting Standards Board, or IASB. In an era of increasingly global markets, convergence of accounting standards, however difficult it might be, seems necessary whether the ultimate goal is mutual recognition or convergence itself. Consequently, the general goal of convergence enjoys wide support.
Of course the devil is in the details - complete or even substantial convergence is a long-term goal. Work must be done not only to agree on an approach, but to determine the underlying principles as well as priorities for the areas of convergence.
In recent years there have been significant strides made towards accounting convergence. For example, the FASB and the IASB made a public commitment to convergence in October 2002 in the so-called "Norwalk Agreement." The goal is to have the same treatment for certain items under International Financial Reporting Standards, or IFRS, and U.S. GAAP. In many areas they seem well on the way to meeting this mandate.
European companies have expressed concern that convergence means moving IFRS to U.S. GAAP, while U.S. companies have expressed concern that convergence means moving U.S. GAAP to IFRS. It is in fact a two-way street. The IASB's recently completed improvements project resulted in converging standards in a number of areas. In December, the FASB issued four Exposure Drafts that would continue to move forward the first phase of the short term convergence project.
In addition to the short-term project, the FASB and IASB are jointly working on several projects on major accounting topics and are developing a coordinated agenda for continuing the convergence effort. In addition, all of the large accounting firms have developed training programs on IFRS, and they all have IFRS expert groups, much like the U.S. GAAP technical practices, or national offices.
What is the SEC view of these convergence efforts? In two words, very positive. Current SEC rules allow foreign issuers to file financial statements based on other systems of accounting, including IFRS, so long as they include an audited reconciliation to U.S. GAAP. The SEC fully recognizes the value of convergence and I am hopeful and indeed expect that there will be a time when the SEC will fully accept IFRS without requiring reconciliation to U.S. GAAP. That day awaits continuing progress on the convergence issue, but things are clearly moving in the right direction.
It will also require further development of mechanisms that assure uniform interpretations of standards in a multiplicity of jurisdictions and effective enforcement mechanisms. In recent years, international cooperation in the area of global financial crimes has flourished, often through the use of MOUs that allow countries to give assistance to other countries who are enforcing their own securities laws. But regulatory convergence also depends on the enforcement and interpretive philosophies within each country.
Even short of full acceptance of IFRS without requiring reconciliations, the SEC recognizes that convergence has many potential benefits. Investors will benefit from primary financial statements based on more converged standards. Regulators will also benefit from working with increasingly converged standards. Finally, reconciliation, where required, will be less significant. In recognition of the benefits of having more non-U.S. companies using IFRS rather than local accounting principles, the SEC last month proposed rule amendments that would provide accommodations to non-U.S. issuers that switch to IFRS in preparing their financial statements.
Interim and Current Reporting. Recent developments in both the United States and Europe make this an interesting time to consider the benefits of interim and current reporting.
The SEC adopted rules last month substantially expanding the current reporting requirements for U.S. issuers. The modifications took the approach that specified unquestionably or presumptively material events should be quickly disclosed to the markets. Specified events include entering into or terminating material non-ordinary course agreements, material events of default, financial restatements, delistings, resignations or appointments of directors or executive officers and incurrence of certain material accounting charges.
The SEC in taking this approach decided not to follow the approach adopted in England, which now has a requirement for current disclosure of material developments generally. The SEC chose its approach in part because of the U.S. enforcement scheme and because of concerns that a more general requirement would cause excessive compliance burdens and costs and would have to be accompanied by an exception for non-disclosure for valid business purposes (such as ongoing material but preliminary merger negotiations), which would threaten to swallow up the rule.
The SEC also did not apply the revised requirements to foreign private issuers. Interim disclosure requirements for those issuers will continue to be dictated, as discussed above, by home country reporting requirements - whether they are expansive, such as England's, or more narrow.
Speaking of home country requirements, I would like to close with some observations regarding interim reporting. The SEC adopted quarterly reporting for U.S. issuers in 1970. The European Parliament has recently chosen not to follow the recommendation of the European Commission to adopt quarterly reporting in the EU.
The decision whether to adopt quarterly reporting raises a number of interesting questions. One is whether a more robust current reporting scheme, requiring quick disclosure of material events, obviates the need for quarterly reporting. In certain respects, where disclosure of material events is involved, the answer may be yes. But in other respects, current reporting does not necessarily capture trends or developments, rather than events, that are unquestionably important to a business. Most importantly, if revenues or earnings are trending up or down as a result of developments in the core business rather than specific events, this information may not be captured by current reporting of material events.
On the other side, there are certainly some who have argued that quarterly reports encourage short-termism on the part of investors, with excessive focus on short-term numbers and insufficient attention to longer term trends in value and the business. One question is whether available material information should be withheld from investors or whether it is excessively paternalistic to do so. Management generally has reliable information about its financial performance more frequently than every six months. Should available, reliable and material information be shared with investors and markets? No one has convincingly argued that issues regarding premature disclosure (such as could be the case with disclosure of negotiations of a merger or material contract) exist with quarterly financial results. It is also probably the case that not having quarterly reporting increases the risk of insider trading.
It also has been suggested that a short-term focus has combined with inappropriate short-term incentives to management to encourage at least some of the financial malfeasance that has been uncovered starting in early 2002. Proper incentives for management and some of the corrective measures that have been taken in a number of jurisdictions might be a better response than not moving to quarterly reporting. In any event, this is an interesting debate, and I think it will continue in a number of jurisdictions.
In closing I would suggest that, notwithstanding the challenges which regulators face, I believe tremendous strides have been made in many areas in seeking global approaches to regulation. I also believe that ongoing communications are critical to success. For example, in addition to dialogue between the U.S. and the EU and the Committee of European Securities Regulators, the U.S. and the EU are both very active in IOSCO, which has led to the development of global principles in a number of areas. Continuing healthy dialogue, directly and through these organizations, is the best recipe for sensible common regulatory approaches and policies.
Thank you again for letting me be with you this evening. I would be pleased to take questions or discuss further any of the points made in my remarks.