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U.S. Securities and Exchange Commission

Speech by SEC Staff:
International Reporting Issues

Remarks by

Craig C. Olinger

Deputy Chief Accountant, Division of Corporation Finance
U.S. Securities & Exchange Commission

26th Annual National Conference on Current SEC Developments

December 9, 1998

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 Mr. Olinger and do not necessarily reflect the views of the Commission, the Commissioners, or other members of the Commission's staff.


Audit Opinion Qualifications

The staff does not accept audit reports that are qualified as to compliance with generally accepted accounting principles.1 However, the staff has not objected to an audit report qualification regarding an exception from compliance with home-country GAAP in rare circumstances involving filings of foreign private issuers. For example, Argentine law once prohibited recognition of price-level adjustments in financial statements, while Argentine GAAP required such recognition, during a time when Argentina did not meet the definition of a highly-inflationary economy. The staff did not object to audit report qualifications for this matter because Argentine registrants had no practicable alternative to resolve the inherent conflict between home-country GAAP and home-country law.

Recently, the staff has received several requests to accept audit report qualifications in circumstances where the registrant has decided to deviate from home-country GAAP to facilitate a position taken for tax purposes, to produce an accounting effect similar to that of a particular accounting principle generally accepted in a different country, or for other discretionary purposes. These deviations are not required by home-country law or regulation, although they may be approved by the home-country securities or industry regulator at the registrant's request. The deviations also would have continuing effects on reported results of future periods, and might be applicable to similar transactions occurring in future periods.

The staff believes that exceptions to the requirement for an unqualified opinion should be limited to circumstances where a qualification is unavoidable because compliance with home-country GAAP would violate home-country law or regulatory requirements, or similar extenuating circumstances. Items 17 and 18 of Form 20-F requires foreign private issuers who elect not to present financial statements in conformity with US GAAP to prepare financial statements "according to a comprehensive body of accounting principles" other than US GAAP. Financial statements that contain deviations from home-country GAAP would not be prepared according to a comprehensive body of accounting principles and would not comply with the requirements of Form 20-F. Adjustment of the deviation as part of the reconciliation to US GAAP would not cure this deficiency.

Registrants who believe that a deviation from home-country GAAP may be unavoidable are encouraged to consult with the staff as early as possible. Neither the prior filing of non-compliant financial statements in the home-country nor prior approval of such financial statements by shareholders will constitute a sufficient basis for acceptance of a deviation from home-country GAAP. Where financial statements that contain a deviation from home-country GAAP have been circulated to shareholders or otherwise made public, the staff would not object to their supplemental inclusion in filings with the SEC under Rule 3-19(f) of Regulation S-X2, provided that the primary financial statements filed under Item 17 or 18 of Form 20-F do not contain the deviation.

Auditor Independence - Fairness Opinions

If an auditor renders an opinion on the value of a company, the adequacy of consideration, or the fairness of a transaction (fairness opinion) that the auditor will subsequently audit, the staff considers the auditor's independence to be impaired.

Statutes or regulations in various countries (particularly in Europe) require companies to obtain a report from a chartered accountant regarding the consideration to be exchanged in stock-for-stock mergers or other non-monetary exchange transactions. Generally, the accountant is expected to review the Board of Director's explanations and justifications of the exchange ratio. The accountant prepares a report addressed to the shareholders of the combining companies, provides assurance of the objectivity of valuation procedures and results, and indicates agreement or disagreement with the selected exchange ratio. Failure to satisfy all legal obligations assumed as part of the appointment may expose the accountant to liability for damages caused to the companies taking part in the merger, their shareholders and third parties. The staff understands that in most countries, management is permitted to engage any duly licensed accountant to perform this service.

In several recent filings, the registrant's auditor performed this service and rendered what appeared to be a fairness opinion. In each case the auditor was unable to confirm that the report did not constitute an opinion on the fairness of the transaction or the adequacy of consideration to shareholders. In these circumstances, the staff considers the auditor's independence to be impaired. The staff may permit registrants in these circumstances to proceed by either engaging another auditor to reaudit the historical financial statements or terminating the current auditor relationship.

It is important to note that the SEC does not accept compliance with foreign independence rules in lieu of or as a substitute for the SEC's independence rules and regulations. In a November 1998 letter to the AICPA's SEC Practice Section, Lynn Turner highlighted this and other troubling independence matters recently noted by the staff. The letter recommends that the SEC Practice Section and its respective members reassess whether the quality controls and training programs of firms and their affiliates that practice before the SEC are adequate to ensure compliance with the independence requirements set forth in the Securities Acts and the Commission's rules and regulations.

Also, Item 4 of Form F-4 requires extensive disclosures about the Board of Director's consideration of a proposed merger or exchange. Where the report of an accountant or other expert is considered by the Board in approving the transaction, the report and consent of the expert must be included in the registration statement.


In August 1998 the Commission issued a cease and desist order against Sony Corporation. The Commission found that Sony violated the periodic reporting requirements of the Exchange Act of 1934. The Commission issued a similar order against Sony's Director of Investor Relations who was found to be a cause of the violations.

The Commission found that during the four months preceding Sony's $2.7 billion goodwill writedown related to its Sony Pictures subsidiary in November 1994, Sony made inadequate disclosures about the nature and extent of Sony Picture's losses and their impact on consolidated results. These deficiencies were contained in the MD&A to Sony's annual report on Form 20-F for the year ended March 31, 1994, as well as in two Form 6-Ks that included copies of Sony's quarterly earnings releases.

Sony Pictures experienced significant losses throughout the periods since its acquisition, but those losses were not disclosed. Instead, disclosures about Sony Pictures focused on positive aspects like revenue trends and Academy Award results. The SEC noted that Sony did not report Sony Pictures as a separate industry segment, but instead combined its results with Sony's highly profitable music business as a single "entertainment" segment, thus obscuring the large losses of Sony Pictures.

The Commission ordered Sony to cease and desist from periodic reporting violations and to comply with three undertakings:

  • to engage an independent auditor to examine its MD&A,

  • to adopt procedures to ensure that its chief financial officer (rather than the Investor Relations officer) will be the primary official responsible for ensuring compliance with public reporting requirements, and

  • to continue to apply recently adopted FASB Statement 131 for its segment reporting.

The Commission also sought and obtained a $1 million civil penalty in a related federal court proceeding.


FASB Statement No. 130 - Reporting Comprehensive Income

At the May 1998 meeting, the Task Force discussed the application of SFAS 1303 to registrants using Item 17 of Form 20-F. The Task Force noted that SFAS 130 defines the required presentation as a new basic financial statement, rather than a disclosure. Thus, a statement of comprehensive income or its equivalent would be required for both Item 17 and Item 18 filers. The staff did not object to this view. A foreign filer may present the statement of comprehensive income in any format permitted by SFAS 130. It may be prepared using either US GAAP or home-country GAAP amounts. Reconciliation to US GAAP is encouraged but not required.

Paragraph 26 of SFAS 130 requires presentation of the components of the accumulated balance of other comprehensive income items on the face of the financial statements or in footnotes. At the November 1998 meeting, the Task Force discussed whether this requirement applies to Item 17 filers, and expressed the view that it does not. The staff did not object to this view.

The Task Force also discussed how Item 18 filers should apply paragraph 26. In certain countries, the equity components under home-country GAAP are included in retained earnings and are not separately tracked. Reconstruction of these amounts may be impracticable. Some believe that the equity components may not be relevant or meaningful for those registrants that elect to present SFAS 130 information on a US GAAP basis, because components of legal capital are determined by reference to home-country laws. Further, the reconciliation requirement in Form 20-F has generally been interpreted to require stockholders' equity to be reconciled to US GAAP in total, not by caption.

The staff is continuing to consider this matter with respect to Item 18 filers and intends to provide guidance as promptly as possible. Pending resolution, the staff will consider requests regarding impracticability or irrelevance on a case-by-case basis.

FASB Statement No. 131 - Segment Reporting

At the December 1997 meeting, the Task Force addressed certain implementation questions regarding presentation of segment information by foreign registrants under SFAS 1314.

  • SFAS 131 requires reported segment information to conform to the information reported by management even if that information is not US GAAP. What information should a foreign registrant report for US GAAP segments? A foreign registrant should present segment information using whatever basis of accounting is used internally, even if that information is on a home-country GAAP basis. No reconciliation of this data to US GAAP is required. As required by SFAS 131, the measurement basis for this data would be disclosed.

  • For purposes of measuring materiality using the 10% criteria in SFAS 131, should the registrant use its internal basis of accounting? Yes. However, the Task Force noted that (as required by SFAS 131) all reported segments must comprise at least 75% of consolidated revenues.

  • In reconciling segment data to the consolidated financial statements, should that consolidated data be home country GAAP or US GAAP? Should the effects of segment reconciling adjustments be isolated from other types of US GAAP reconciling items? The final column in the segment data reconciliation should be the consolidated financial statements under home country GAAP. The reconciling items should be isolated in a separate column and described.

  • If the consolidated financial statements are presented in US dollars and the internal management statements are presented in parent or local currency, what currency should be used to present the segment data? All financial statement information should be reported in the same currency. Accordingly, the segment data should also be in US dollars.

    The staff did not object to the preceding views.

    The Task Force has noted possible differences between the types of segments that would be reported under IAS 145 and SFAS 131 that could require certain registrants to present two sets of segment data. The Task Force expects to discuss this matter at its April 1999 meeting.

    Consolidation of Foreign Subsidiaries by Mexican Registrants

    At the December 1997 meeting, the Task Force discussed the consolidation of foreign subsidiaries by Mexican registrants. The issue is whether the methods of consolidation and translation specified by Bulletin B-15 under Mexican GAAP are consistent with (1) a comprehensive basis of price-level adjusted accounting, and (2) the requirement of Rule 3-20(e) of Regulation S-X6 to present financial statements for all periods in the same reporting currency. If not, then Mexican GAAP financial statements of registrants with material foreign operations would not be considered acceptable in filings with the SEC.

    At the May 1998 meeting, the Task Force expressed the view that, for the most recent period being presented, the methods specified by Bulletin B-15 are consistent with a comprehensive basis of price-level adjusted accounting. For the most recent period being presented, the staff would not object to the use of the accommodation in Form 20-F that permits registrants to not remove the effects of inflation accounting when reconciling to US GAAP.

    The staff expressed the view that the Bulletin B-15 methods would not comply with Rule 3-20(e) with respect to comparative periods. However, the Task Force noted that Bulletin B-15 accomplished the goal of establishing consistent principles for Mexican companies, and that there is no definitive guidance in US GAAP. The staff concluded that it will not object to comparative financial statements prepared in conformity with Bulletin B-15, provided that the registrant quantifies the aggregate effects of the departure from Rule 3-20(e) in its reconciliation to US GAAP and provides extensive footnote disclosures about the effects on major balance sheet, income statement, and cash flow captions. The minutes to the May 1998 meeting outline the disclosure guidance developed by the Task Force.

    At the December 1997 meeting, the Task Force expressed a similar view that the method permitted by the Fifth Amendment to Bulletin B-10 for restating fixed assets of foreign origin was not consistent with a comprehensive basis of price-level adjusted accounting. The staff concluded that a reconciling difference should be reported based on the amount using the Mexican consumer price index (NCPI).

    Price-Level Adjusted Cash Flow Statements

    At the November 1998 meeting, the Task Force continued to discuss the presentation of the statement of cash flows by registrants that prepare price-level adjusted financial statements in filings with the SEC. SFAS 95 and Form 20-F do not address this matter. This issue primarily affects registrants from Mexico, Brazil, and certain other countries where home-country GAAP/home-country currency financial statements are adjusted for inflation.

    The Task Force noted that inclusion of the effects of inflation in the line items comprising the three major categories of the cash flow statement may make the presentation less meaningful and possibly misleading. For example, the financing activities section may depict reductions of foreign-currency denominated debt because of the recasting of prior balance sheet amounts for inflation, even though no cash repayment has occurred. In some cases, these effects may permeate the statement of cash flows. Historically, these effects have only been partially captured in the US GAAP reconciling disclosures.

    The issue is whether registrants should be required to prepare price-level adjusted cash flow statements in a manner that comprehensively segregates the effects of inflation/currency devaluation from the cash flows from operating, investing and financing activities. The Task Force noted that presentation of a "fourth caption" that captures these effects has been adopted in several countries (Chile, Columbia).

    The staff concluded that registrants should be required to prepare price-level adjusted cash flow statements in a manner that comprehensively segregates the effects of inflation from the cash flows from operating, investing and financing activities. The November 1998 Task Force minutes will include an illustrative example as well as references to the Chilean cash flow standard.

    Noting the difficulties of retroactive compliance, the Task Force expressed the view that this guidance should be adopted for fiscal years ending after November 1998. Recasting of comparative periods is encouraged but not required. The staff did not object to this approach.

    Mexico's Status as a Highly Inflationary Economy

    At the May 1998 meeting, the Task Force discussed whether Mexico should no longer be considered highly inflationary. At that time, the cumulative three-year index had just fallen below 100%. Because of concerns about Mexico's historical recurring inflation patterns, the Task Force expressed the view that the decline below 100% was not "other than temporary" as contemplated by EITF Topic D-557. The Task Force indicated that it would not be appropriate to cease hyperinflationary accounting for Mexican operations before December 31, 1998. The staff did not object. The Task Force agreed to update its discussion at its November 1998 meeting.

    At the November 1998 meeting, the Task Force noted that three-year cumulative inflation had continued to decline throughout 1998 and fell below 80% as of September 1998. The Task Force expressed the view that the decline should no longer be considered temporary, and that Mexico should no longer be considered highly inflationary as of December 31, 1998. Thus registrants should cease hyperinflationary accounting for periods beginning after December 31, 1998.

    The staff believes that registrants with material Mexican operations should provide the following disclosures in the financial statements and MD&A:

    • a description of Mexico's status as a highly inflationary economy,

    • the date Mexico ceased being considered a highly inflationary economy,

    • the functional currency used by the Mexican operations, and

    • the effects on the financial statements of the change in the functional currency, if practicable.

    Russia's Status as a Highly Inflationary Economy

    At the November 1998 meeting, the Task Force also discussed Russia's inflationary status. While Russia's cumulative three-year inflation index appears to have dropped below 100% for a very brief period during 1998, the seriousness of the subsequent adverse developments there led the Task Force to conclude that Russia should continue to be considered highly inflationary.

    The Task Force noted that the inflationary status of the other former Soviet states should be individually evaluated, if applicable. The staff has noted instances where registrants from emerging countries have looked to industrial price indexes or changes in currency exchange rates (devaluation) against the dollar rather than the general consumer price index. The staff has objected because these approaches conflict with FASB Statement No. 52.


    Accommodation in Item 17 and 18 for Proportional Consolidation

    Issuers that use proportional consolidation under home country GAAP for investments in joint ventures that would be equity method investees under US GAAP may omit reconciling differences related to classification or display, and instead provide summarized footnote disclosure of the amounts proportionately consolidated8. The accommodation is only available if the joint venture is an operating entity, the significant financial operating policies of which are, by contractual arrangement, jointly controlled by all parties having an equity interest in the entity.

    The staff has recently noted situations where the accommodation was used for investees that were characterized as joint ventures but not all parties with an equity interest had the right to share in control. For example, a supermajority voting provision permitted several large equity holders to control the investee without the consent of several small equity holders. The staff has objected to use of the accommodation in these circumstances.

    Consolidation of Chinese Joint Ventures and Related Issues

    The staff has recently reviewed several registration statements where the registrant's business was conducted primarily through "joint venture" arrangements in the Peoples Republic of China. Generally, the underlying businesses were infrastructure projects such as toll roads or water distribution systems. The joint venture was formed by the contribution of capital by the registrant, and contribution of the underlying project by a PRC municipal government entity (PRC partner). The joint venture acquired a long-term concession to operate the project.

    Generally, the registrant owned the majority of the voting shares of the joint venture, and the PRC partner owned the remaining shares. The registrant also selected a majority of the directors of the joint venture. However, unanimous approval by the board of directors was required for numerous operating decisions. Examples include selection and termination of key operating and financial officers, approval of budgets, capital expenditures and borrowings in the ordinary course of business. One agreement required unanimous approval of all matters pertaining to the planning, construction, operation, and maintenance of the toll road.

    In these circumstances the staff believed that these rights were substantive and pervasive. They should not be considered "protective" as contemplated in EITF 96-169. Because the PRC partner retained significant rights and authority over operating decisions despite relinquishing majority ownership, the staff believed that the registrant did not have a controlling financial interest in the joint venture. Accordingly, the staff objected to consolidation of these joint venture under US GAAP. The staff may also challenge consolidation in the primary financial statements where control under home-country GAAP is based on the existence of these rights rather than the specific exercise of these rights.

    This matter also creates various presentation issues. If consolidation is permitted under home-country GAAP, reconciliation of all financial statement captions will likely be required. In the selected financial data, the staff would expect home-country and US GAAP amounts to be presented with equal detail and prominence.

    Separate audited financial statements of each joint venture under Rule 3-09 of Regulation S-X10 may be necessary. If consolidation is permitted under home-country GAAP, the staff will consider accepting expanded footnote disclosures about the joint ventures, such as separate condensed balance sheet, income statement, and cash flow information for each joint venture, in lieu of Rule 3-09 financial statements. The staff would also expect MD&A to address the significant presentation differences between home-country GAAP, and to include meaningful discussion of the results of operations, liquidity and cash flows of the ventures and their impact on the registrant.

    In some of these arrangements, an affiliate of the PRC municipal government provides financial support in certain circumstances. Where significant, financial statements or other financial information about the affiliate may be required.

    Selected Financial Data Waivers

    The staff has been receiving more expansive requests for relief from the selected financial data requirements. We generally will grant waivers for initial filers where data for the fourth or fifth prior year would not be meaningful or reliable because of a privatization transaction or other fundamental change in the underlying business. However, we believe that selected data for the third year would virtually always be necessary for a meaningful presentation of trends. We have also rejected recent waiver requests where data depicting adverse trends in revenues and operating profits was available but omitted because of concerns over reliability of corporate overhead allocations. Also, registrants that use US GAAP in the primary financial statements should provide 5 years of home country GAAP selected financial data (unless waived) if US GAAP data is unavailable for the earlier years.

    Recognition of Contingent Gains

    Under GAAP in certain countries, contingent gains are recognized prior to their realization based on a probability concept. Paragraph 17 of SFAS 5 states that "contingencies that might result in gains usually are not reflected in the accounts since to do so might be to recognize revenue prior to its realization. Some registrants have interpreted the word "usually" to mean that US GAAP is permissive in this area. The staff believes that the circumstances where recognition of a contingent gain could be justified under US GAAP prior to realization of cash are extremely rare.

    1 See Staff Accounting Bulletin Topic 1:E.2.

    2 Rule 3-19, Special Provisions as to Financial Statements for Foreign Private Issuers.

    3 Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income.

    4 Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information.

    5 International Accounting Standard No. 14 (revised), Reporting Financial Information by Segment.

    6 Rule 3-20, Currency for Financial Statements of Foreign Private Issuers.

    7 EITF Topic D-55, Determining a Highly Inflationary Economy under FASB Statement No. 52.

    8 Statement of Financial Accounting Standards No. 52, Foreign Currency Translation.

    9 EITF 96-16, Investor's Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights.

    10 Rule 3-09, Separate Financial Statements of Subsidiaries Not Consolidated and 50 Percent of Less Owned Persons.