Remarks at ICAEW Event – World-Class Regulation: Building Trust and Transparency in International Markets

Thank you, Julia [Penny][1] for that introduction.  And thank you to the ICAEW for inviting me to share some thoughts on corporate accounting standards in a global context, particularly between the United States and the United Kingdom.  New York and London have been top destinations for corporate issuers to raise capital, and one significant factor has been high-quality financial reporting requirements for companies listed in those jurisdictions. My remarks reflect solely my views as an individual Commissioner of the U.S. Securities and Exchange Commission (the “Commission” or “SEC”) and do not necessarily reflect the views of the full Commission or my fellow Commissioners.

Importance of Accounting Standard Setting

I joined the SEC in 2006, which was then under the leadership of Chairman Christopher Cox.  During his tenure at the SEC, the agency made one of the most significant changes for expanding cross-border capital markets.  In 2007, the SEC amended its rules to allow certain non-U.S. companies – referred to as foreign private issuers – that prepared their financial statements in accordance with international financial reporting standards (“IFRS”), as issued by the International Accounting Standards Board (“IASB”), to include them in SEC filings without reconciliation to the generally accepted accounting principles used in the United States (“U.S. GAAP”).[2]  In making this change, the SEC highlighted that its decision was based, in part, on “the ability of the IASB to continue to develop high-quality globally accepted standards.”[3]

Even though more than fifteen years has elapsed since the SEC made that statement, the need for, and emphasis on, high-quality accounting standards remains the same.  Such standards provide investors with confidence that the financial statements they review are accurate, transparent, and comparable.  Without these standards, financial statements become unreliable.  This harms not only investors, but also companies and markets, as price discovery by the market is impeded and the flow of capital becomes inefficient.  In the case of IFRS, these implications are heightened because use of such standards transcends national borders.  Fifteen of the G20 countries have adopted IFRS for all or most of their public companies.[4]  Accordingly, any failure by the IASB to adapt and update IFRS to keep pace with complicated and evolving financial transactions could have profound implications on the global markets.

Maintaining high-quality accounting standards is not an easy task and should not be a foregone conclusion.  Although ChatGPT has helped write an opinion letter in the New York Times[5] and a highly graded essay at Cardiff University,[6] it did not write this speech and likely cannot write a framework for measuring fair value or the principles governing when a company should recognize revenue.  Not yet anyway.  Rather, that task continues to fall on the dedicated staff of the IASB and the IFRS Foundation, as well as the Foundation’s leadership – the Trustees.

When the IFRS Foundation proposed to create the International Sustainability Standards Board (“ISSB”) in early 2021, my fellow SEC Commissioner, Hester Peirce, submitted a comment letter where she outlined concerns with the new board.[7]  One of the concerns was the ISSB’s potential drain on the Foundation’s “time, resources, and attention,” which necessarily would come at the expense of the IASB.[8]  The ISSB was ultimately created and is currently in its second year of existence.  In March 2022, the ISSB published the exposure drafts for its first two standards, on general sustainability-related disclosures[9] and climate-related disclosures.[10]  As the ISSB works towards finalizing these two standards, the concerns voiced by Commissioner Peirce apply as much today as they did two years ago.  The IFRS Foundation and its Trustees must not lose sight of the importance of accounting standard setting and must ensure that the IASB receives the time, resources, and attention needed for its critical mission.

Updating Accounting Standards – Crypto Assets

An important aspect of quality accounting standard setting is updating and improving standards over time, especially in response to evolving financial transactions and practices.  In the United States, the Financial Accounting Standards Board (“FASB”) is tasked with maintaining U.S. GAAP.  FASB is currently working on several updates to these standards, including accounting for and disclosure of certain crypto assets held by entities.  There has been a strong push in the last few years to ensure that regulations keep pace with the growth of the crypto industry, and that regulatory emphasis has intensified since the collapse of FTX late last year.  FASB’s effort to update its standard on the measurement, presentation, and disclosure of crypto assets are a part of these efforts.  As a lawyer speaking in front of a group of mostly accountants, I will not delve deeply into the technical aspects of this update, at the risk of misstating something and for which you will be too polite to correct me.

But generally speaking, FASB issued its exposure draft for the updated standard in March 2023.[11]  The proposed update would add a new subtopic covering certain crypto assets to ASC[12] 350, which governs the accounting for intangible assets.

Currently under U.S. GAAP, if an entity holds third-party crypto assets meeting certain criteria, then it accounts for those assets as indefinite-lived intangible assets, subject to certain industry-specific exceptions.  Entities cannot amortize these assets over time.  Instead, if a crypto asset’s fair value falls below its carrying amount, then the entity must write down, or impair, the asset to its fair value.  This impairment cannot be reversed, even if the fair value subsequently increases.  An entity would not recognize any increase in the value of its crypto assets until they are sold.

FASB has proposed to amend these requirements and would instead require entities to measure certain crypto assets at fair value.  Such crypto assets would be presented separately on the balance sheet, apart from other intangible assets.  Any increase or decrease to the fair value during a period would be recognized as part of that period’s net income and reported separately on the income statement.  Furthermore, transaction costs to acquire a crypto asset, such as commissions and other fees, would be expensed as incurred, unless otherwise permitted to be capitalized.  An entity would also need to provide additional disclosure in its annual and interim financial statements regarding each significant crypto asset that it holds.

There will likely be different perspectives on FASB’s proposed updates.  Some may agree that the proposed update better reflects the economics of holding certain crypto assets, while others may prefer the current accounting model.  Many may believe that change is needed but do not agree with every aspect of the proposed update.  Whatever the final standard may be, FASB’s efforts for updating them is commendable.  It proposed the updated standard in response to feedback that the current standard does not provide stakeholders with appropriate information.  In the exposure draft, FASB sets forth its ideas and rationale for why the proposed change to the current standard would be an improvement to U.S. GAAP.  Perhaps most importantly, it is soliciting public feedback on its proposed update.  Comments are due by June 6, which is 75 days after FASB published the exposure draft.  This is 15 days more than the minimum of 60 required by FASB’s procedures for this type of update.[13]  This process highlights the time, resources, and attention required to maintain high-quality accounting standards, and is a good example of an effective approach to crypto regulation.

A discussion of updates to U.S. GAAP is not complete without a discussion of how the update affects the convergence between U.S. GAAP and IFRS.  FASB’s proposed update, if adopted, would likely bring U.S. GAAP closer to IFRS in terms of accounting for some of the types of crypto assets.  Currently, under IFRS International Accounting Standard (“IAS”) 38, entities have the option of reporting crypto assets with an active market based on a revaluation model.  Under this approach, an entity records a crypto asset on its balance sheet at fair value, similar to FASB’s proposed standard.  However, there are important differences between IAS 38’s revaluation model and FASB’s proposal, including (1) the revaluation model being elective and not mandatory, (2) the need for an active market for the crypto asset to use the revaluation model, and (3) gains above the original cost being recognized in the revaluation model as part of other comprehensive income, rather than net income.  Given FASB’s proposed update and the growth of crypto assets, I am hopeful that the IASB is also evaluating whether there should be updates to IFRS on the accounting for crypto assets.

Accounting Violations – Implications and How to Prevent Them

Notwithstanding the high-quality accounting standards under IFRS or U.S. GAAP, there will always be errors and noncompliance with financial reporting requirements.  I will first share some statistics for the SEC’s accounting and auditing-related enforcement actions during the fiscal year that ended September 30, 2022.  During that year, the agency initiated 68 enforcement actions.[14]  This represented a 55% increase from the prior fiscal year but was below pre-pandemic levels.  Only five of the 68 actions were against non-U.S. respondents, which, on a percentage basis, was less than prior fiscal years.  The most common violations were revenue recognition, in 30 actions, and internal control over financial reporting, in 28 actions.  Of the 68 actions, 36 were against individuals only and did not involve a firm.  This represented 53% of the actions and was significantly higher than the five prior fiscal years, which averaged 37%.  Finally, during the last fiscal year, 38 individuals resolved their case with the agency and were assessed civil penalties in a median amount of $20,000.  Twenty-seven firms resolved their case and incurred civil penalties in a median amount of $1.8 million.

Besides the SEC, the Public Company Accounting Oversight Board (the “PCAOB”) in the United States can also bring enforcement actions against auditors.  The PCAOB oversees the audits of public companies.  During the year ended December 31, 2022, the PCAOB brought 29 disciplinary actions, which is a 60% increase over the prior year.[15]  More notably, the PCAOB imposed $10.5 million in monetary penalties during 2022, compared to $1.1 million in 2021.  Furthermore, 52% of the PCAOB’s actions in 2022 were against non-U.S. respondents, compared to 33% in the prior year.

The SEC’s enforcement authority for accounting violations goes beyond imposing civil penalties.  In at least a couple of actions last year, the SEC also sought to claw back executives’ bonuses and profits from sales of company stock, pursuant to Section 304 of the Sarbanes-Oxley Act of 2002.[16]  Under this legislation,[17] the SEC may recoup, on behalf of a company, any bonuses or incentive-based or equity-based compensation paid to, or profits realized from the sale of stock by, the company’s CEO or CFO if the company is required to restate its financial statements due to material noncompliance, as a result of misconduct, with financial reporting requirements.[18]  It is irrelevant as to whether the CEO or CFO was engaged in the misconduct.

In addition to Section 304, the SEC recently adopted another clawback rule related to accounting restatements that was mandated by the Dodd-Frank Act of 2010.[19]  This rule requires U.S. stock exchanges to mandate that their listed companies, including foreign private issuers, adopt a clawback policy related to accounting restatements, including “little r” restatements.  The policy must require the company, subject to limited exceptions, to recoup excess incentive compensation from current and former executive officers if the company is required to restate its financial statements due to material noncompliance with financial reporting requirements.  The policy applies regardless of whether the noncompliance was due to misconduct.  Under the current implementation timeline, companies will need to adopt their clawback policy by mid-August of this year.[20]  This new rule is much broader than Section 304, including its application to “little r” restatements and executive officers other than the CEO and CFO.  Going forward, clawbacks pursuant to this rule may become a significant process that companies will need to go through whenever it engages in a restatement.

Accounting violations is a focus for the SEC.  For companies, a strong audit committee can help lower the likelihood of such violations by actively overseeing and understanding the accounting policies, estimates, and judgments made by management in their preparation of the financial statements.  Carrying out this duty requires insight into whether the controls and procedures related to financial reporting are effective.  Another important responsibility of the audit committee is to appoint, compensate, and oversee the company’s auditor.  This responsibility includes determining that the auditor is independent under the myriad of rules that govern independence.  Finally, the audit committee should contribute to a culture of cooperation between management and the auditor, while still ensuring that differing views on important issues are raised to the committee.

Recent rules proposed by the SEC have sought disclosure of whether the company’s board members have expertise in certain non-financial areas.[21]  These disclosure requirements may result in companies dedicating board seats to cover those non-financial areas.  This practice creates the risk that the board may not have sufficient members who are knowledgeable about the company’s financial reporting and core business.  For example, recent failures by certain U.S. regional banks have raised questions as to whether those boards had sufficient knowledge and appreciation of interest rate risks associated with their banks’ deposits and investments.  The SEC should have a limited role in influencing a company’s board composition, and any regulations should focus on ensuring that the company produces accurate financial statements, as that is the most important information that drives a company’s value and on which investors will base their investment decision.

Sometimes, even the most high-functioning audit committee will not be able to prevent accounting violations at a company.  When this happens, a potential cause is the activities of one or more bad actors within the company’s management.  When bringing enforcement actions in these instances, the SEC should continue to focus on pursuing those individual bad actors and levying appropriate remedies against them.  An enforcement program focused solely on charging and imposing monetary penalties on firms, without parallel actions to hold individuals accountable, will mostly harm the firms’ current shareholders and will not discourage individuals from becoming bad actors in the future.  Accordingly, charges and penalties against individuals serve as the strongest disincentive against people becoming bad actors and engaging in the same activities in the future. 

Conclusion

Thank you for allowing me to participate in this cross-border event with you.  Our countries have a tremendous partnership and history and share the same values in so many areas.  Having a robust process to establish and maintain high-quality accounting standards, as well as an effective board composition and regulatory regime to prevent financial reporting violations, should continue to be among them.