Saturday, February 6, 2010

SEC Speaks: We Listen

Sunshine may be the best disinfectant, but all the luminaries of the SEC combined - out in force at Day 1 of the Practicing Law Institute's annual SEC Speaks conference yesterday - could not melt away the threat of a Deadly, Epic Snowstorm (CNN), which was predicted to drop a total of 20-30 inches of snow in the Washington, DC area between Friday and Sunday, prompting DC Mayor Adrian Fenty and the governors of Maryland, Virginia and Delaware, to declare a state of emergency (authorizing assistance by the National Guard).

In Region Hasn't Seen This Much Snow Since 1922, WTOP's Nathan Hager tells the story behind the current record-holder, the Knickerbocker Storm of 1922, expected to turn over the crown to this weekend's storm: "Twenty-eight inches of snow fell from Jan. 27 to 28 that year [1922], killing 98 people inside the packed Knickerbocker Theater in Adams Morgan, at the time Washington's largest and newest moviehouse. The roof collapsed and the building was destroyed under the weight of all that snow." He adds, "The threat of roof collapse along the lines of the Knickerbocker incident has lessened over the past 88 years. Buildings are built to better standards in 2010."

PLI - perhaps not surprisingly as an organization dedicated to lawyers - took no chances of any untoward snow-related events impacting its speakers or attendees at its conference venue, the International Trade Center; and in consideration of impending air, rail, and local transport issues (see Washington DC Paralyzed as Snow Piles Up), (and other potential storm-related issues, including potential power interruptions) took what appears to be the unprecedented move of cancelling Day 2 of its two-day conference. Similarly, the SEC Alumni Association (ASECA) cancelled its annual dinner slated to take place Friday evening at the International Trade Center. NOTE: Both organizations (PLI and ASECA) intend to reschedule the cancelled events, as noted on their websites.

Nevertheless, neither rain, nor snow, nor sleet could stop Day 1 of PLI's SEC Speaks, and thanks to the wonder of simultaneous webcasting, we were able to catch some of the highlights, particularly with respect to the Accounting Panel, as noted further below.

Highlights of Highlights:
IFRS Roadmap, Auditor Independence, Textron, Venezuela, Fair Value

Within the highlights of the Accounting Panel further below, I would call to your attention in particular Chief Accountant Jim Kroeker's remarks on the status of the proposed IFRS Roadmap - in which he notes the SEC staff is currently developing a 'workplan' to address structural and transitional issues identified in comment letters. He also noted that, as the SEC continues to focus on the objective [presumably the objective of a single set of global accounting standards], it will be with an eye toward "mak[ing] sure it is in the best interests of the capital markets and investors."

I would also point out remarks of Jeff Minton, Chief Counsel in the Office of the Chief Accountant, on some auditor independence issues the SEC is seeing, as well as his reference to the Textron case (which indirectly relates to matters of 'cooperation' discussed under the separate Enforcement panel).

Other hot topics include disclosures relating to currency valuation issues in Venezuela, discussed by Corp Fin Chief Accountant Wayne Carnall, and an interesting question 'backtesting' fair values raised by former Commissioner Cynthia Glassman, a commentator on the accounting panel.

Upcoming And Continuing Initiatives
SEC Chairman Mary L. Schapiro, providing the opening address at Day 1 of the SEC Speaks conference yesterday, emphasized changes she has implemented to strengthen the agency since taking its helm one year ago.

Among the many upcoming and continuing initiatives listed in her remarks, "Looking Ahead, Moving Forward," here are a few that Schapiro listed:
  • Short Sales: ...[I]n the past year, we adopted rules that seek to reduce the potential for abusive "naked" short selling in the securities market. These rules have significantly reduced the number of times short sellers failed to deliver securities. Looking ahead, in the coming weeks, we will consider proposals to restrict the practice of short selling.
  • NRSROs: Also, in the year ahead, I hope we can adopt a strong set of rules that would create an even more robust regulatory framework for credit rating agencies — a framework that includes further measures designed to improve the quality of ratings by requiring greater disclosure, fostering competition, helping to address conflicts of interest, shedding light on rating shopping, and promoting accountability.
  • Proxy Access: And, I am hopeful that we will adopt rules to facilitate the effective exercise of the rights of shareholders to nominate directors to the Boards of the companies they own. This so-called proxy access rule is designed to increase shareholders' ability to hold boards accountable.
  • Money Market Funds: More recently, we adopted rules that will make money market funds more resilient by strengthening their credit quality, liquidity and maturity standards. Our rules also establish a new on-line disclosure regime for money market funds — including disclosure of a fund's "shadow" or mark-to-market NAV — and our rules take steps to limit the disruption caused by any fund "breaking the buck," or falling below the standard $1 net asset value.... Looking ahead, we will be considering yet more measures to address money market fund risk, especially the risk of a run on money market funds. In particular, I have directed our staff to examine the merits of a floating, mark-to-market NAV for money market funds, rather than the stable $1 price. Other ideas under consideration include mandatory redemptions-in-kind for large redemptions (such as by institutional investors); "real time" disclosure of "shadow" NAV; a private liquidity facility to provide liquidity to money market funds in times of stress; and a possible "two-tiered" system of money market funds, with a stable NAV only for money market funds subject to greater risk-limiting conditions and possible liquidity facility requirements.

Among other issues the SEC will tackle, detailed further in Schapiro's remarks:

  • Market Structure (including high frequency trading, flash orders, and more),
  • Consolidated inter-market audit trail for market surveillance conducted by self-regulatory agencies (consideration of building a consolidated intermarket audit trail)

Challenges In Reaching Consensus
Before we move on to the other Commissioner's remarks and highlights from the Accounting Panel, we'd like to note that throughout its history - to varying degrees based on particular issues and commissioners - the five-member Commission has sometimes faced challenges in reaching consensus on rulemaking initiatives and other issues. This balancing of different points of view is, in part, hard-wired into the commission's design, intended as a bipartisan commission, as described on the SEC website:

The Securities and Exchange Commission has five Commissioners who are appointed by the President of the United States with the advice and consent of the Senate. Their terms last five years and are staggered so that one Commissioner's term ends on June 5 of each year. To ensure that the Commission remains non-partisan, no more than three Commissioners may belong to the same political party. The President also designates one of the Commissioners as Chairman, the SEC's top executive.

Kara Scannell notes some of these challenges in her article on Page B1 of today's Wall Street Journal, SEC Discord Could Stymie Schapiro's Efforts. (Hat tip to Prof. Bob Jensen who highlighted the article on the AECM listserve earlier today.)

Some of what Scannell refers to as 'discord' among the commissioners, includes the 3-2 vote last week (along party lines) in favor of releasing Interpretive guidance on climate change disclosures. As noted in Commissioner Kathleen Casey's remarks at the Jan. 27 open commission meeting:

There is undoubtedly a constituency that is interested in, and has long pressed the Commission to require, more extensive disclosures on environmental issues in order to drive particular environmental policy objectives. The issuance of this release, however, at a time when the state of the science, law and policy relating to climate change appear to be increasingly in flux, makes little sense.

Most importantly, I do not believe that this release will result in greater availability of material, decision-useful information geared toward the needs of the broad majority of investors.

At the SEC Speaks conference yesterday, Casey outlined a 'top 10' list that she said should guide the commission in rulemaking and other initiatives, reinforcing some of the points made in her earlier remarks on Jan. 27. (If Casey's remarks at SEC Speaks are posted on the SEC website, we will add a link here.)

Separately, Commissioner Elisse Walter emphasized in her remarks at the SEC Speaks conference how the agency's due process (i.e. reaching out to constituencies formally through the comment letter process on proposed rulemaking, and informally through other dialogue with industry, investor, and other groups and individuals) supports the commission's rulemaking objectives and mission. (If Walter's remarks are posted on the SEC website, we will add a link here.)

Additionally, Commissioner Luis Aguilar's remarks appeared directed at the SEC and the broader regulatory and legislative community as well, in calling for decisive action on financial regulatory reform.

[D]espite the intense focus on financial reform over the last year, very little has changed. Last year, I stood here and spoke about the need for sustainable regulatory reform oriented towards investors. It is clear that the need is even greater today.

John Wooden, the legendary UCLA basketball coach, used to say: "Never mistake activity for accomplishment." This adage perfectly sums up the last year. While there was much activity this past year, very little has actually been accomplished. There have been many speeches given and many preliminary steps taken toward regulatory reform, but for all the activity, reform itself has yet to be achieved. For example, despite the clearly demonstrated need, OTC derivatives, hedge funds, and municipal securities markets still lack appropriate regulation, and our inspection and enforcement efforts in these areas continue to be severely undermined.

Moreover, there are those who are using the process of reform as an opportunity to weaken strong investor-focused laws arising from lessons learned in prior crises. In my remarks today, I will highlight the progress we have made and the distance we have to go.

Also slated to provide remarks on Day 1 of the SEC Speaks conference was Commissioner Troy Paredes. (If Paredes' remarks are posted on the SEC website we will add a link here.)

Highlights From Accounting Panel

In addition to the Chairman's and Commissioner's remarks, Day 1 of the SEC Speaks conference included plenary session panels on Accounting, Enforcement, Corporation Finance, and Trading & Markets. The panels featured senior staff from those divisions and offices, with former SEC chairmen and commissioners serving as commentators. Additionally, a number of breakout group/workshops on the above topics were slated to take place at the end of the day.

Following are highlights from the Accounting Panel, featuring remarks by Jim Kroeker, Chief Accountant, Office of the Chief Accountant, Jeff Minton, Chief Counsel, Office of the Chief Accountant, Wayne Carnall, Chief Accountant, Division of Corporation Finance, Jason Flemmons, Associate Chief Accountant, Division of Enforcement, and Rick Sennett, Chief Accountant, Division of Investment Management. Commentators on the Accounting Panel included former Commissioners Roel Campos, Ed Fleischman and Cynthia Glassman. (NOTE: items shown in "quotes" are direct quotes of the speaker.)

James Kroeker, Chief Accountant, Office of Chief Accountant

Investor views preeminent: The SEC wants input from all constituents on rule proposals, other matters; "I highlight investors because their perspective ought to be preeminent.”
Reach out: Issuers, auditors are encouraged to reach out formally and informally to OCA, such as through the 'preclearance' process.

"Fair Value is Here to Stay," said Kroeker, adding it is important for people to monitor, comment on FASB and IASB proposals.

Former Commissioner Cynthia Glassman asked if the SEC has ‘backtested’ fair value amounts, i.e., "what they ultimately turned out to be worth, to see if it is an appropriate measure going forward.” Kroeker replied, “That is something the Division of Corporation Finance considers in terms of its disclosure rules, what entities are doing to ‘backtest,’ if you will, Fair Value.” He added, “the objective is not one of using hindsight… [or] calling into question judgments reached at Dec. 31, 2009; if an entity later sells [the asset] but [the amount at which it is sold] differs from the estimate, that doesn’t immediately call into question the estimate.”

Wayne Carnall of the Division of Corporation Finance added, “Values are constantly changing; that does not automatically mean [the estimate was] wrong.” However, Carnall noted, “if we see something unusual.. we ask lots of questions,.. about compliance with FAS157 [Fair Value Measurement]... .if ...looks contrary to market expectations, we will certainly ask questions in that regard.”

SEC IFRS 'Workplan' Being Developed

Kroeker said that, as a result of analyzing the 238 comment letters received on its proposed IFRS Roadmap, staff from the SEC’s Office of Chief Accountant, Division of Corporation Finance, Office of International Affairs, and Division of Enforcement are working closely together, “developing a workplan to focus on what are the transitional, structural issues that need to be addressed, focus[ed] on,” with respect to the IFRS Roadmap.

He defined 'structural' issues as: ‘do we [presumably, does the IASB] have sufficient independence, accountability to securities regulators or to those charged with setting accounting standards in capital markets?" ‘Transitional issues’ were defined by Kroeker by way of these examples: "if we move to IFRS in the US , how [would it] impact things like regulatory capital requirements, would you be required or permitted to use [IFRS] in Call reports for financial institutions; or [for tax/IRS purposes] LIFO inventory… LIFO isn’t an option under IASB standards, what would that do to a $ billion dollar-plus tax benefit because of LIFO inventory."

In general, Kroeker noted, "We should continue to focus on this objective" - [although he didn't specify 'the objective' - it is presumably the achievement of a single set of global accounting standards] - “but if we do, to make sure it is in the best interests of the capital markets and investors … and if it can’t be, how do we identify what those are.”

Pursue Convergence Around High Quality Standards

“Notwithstanding any of the follow-up to the [IFRS] Roadmap,” said Kroeker, “I believe convergence is an objective we have to continue to pursue,” noting that “decisions in the US are impacted by standard setters globally and vice versa.”

Referencing “pressure put on the IASB” to permit certain reclassifications, and pressure put upon the FASB and the IASB more generally calling for a ‘level playing field,’ Kroeker said, “I think in some cases… [there is] pressure to push to the lowest common denominator.” He emphasized, “ important... but around a high quality set of standards.. insuring it isn’t taking this piece of US GAAP and this piece of IFRS.. that is the worst piece… and combining [those]; that wasn’t [the goal] of convergence, and won’t be going forward.”

What Should Companies Do Now?
Kroeker observed, "[During] this period of ‘consideration and uncertainty…” until the SEC makes its next move on the IFRS Roadmap, some companies are getting questions, such as 'should we engage people now to put in new systems' to prepare for a move to IFRS. "My advice," said Kroeker, "is: (1) Expect time to prepare [for IFRS]; we understand, [it is] very clear in comment letters, people will need time to prepare if the decision is to move to a global set of standards.(2) IASB and FASB have a number of projects on their agenda what would fundamentally change.. [accounting]… .so investing in new systems [now] would [seem] to be premature. (3) (as noted above) monitor FASB and IASB [proposals]… to comment [on them]"

Former Commissioner Roel Campos asked how issues of practicability and transition are being considered, particularly with respect to smaller public companies and private companies.

Kroeker responded, "We have to arm ourselves with real data, study what would be the real impact." He added, "Our responsibility is financial reporting for public companies, but I don’t think we can be blind to the impact on small business, and private companies." Campos commented, "Consider how many small public companies there are...." Kroeker replied, " we have more important, first order issues, structural [issues], and should we continue to pursue [the objective]."

Other matters covered by Kroeker included "OCA Considerations in Evaluating Accounting Issues," and a brief update on the PCAOB. He described the PCAOB as having an "aggressive and appropriate standard-setting agenda" including development of risk assessment standards, including as relate to fraud risk, and consideration of engagement partner signature.

Jeff Minton, Chief Counsel, Office of Chief Accountant

Auditor Independence issues: Companies contemplating going public, should keep in mind: they will need 3 years of audited financial statements, by an auditor that meets SEC and PCAOB independence requirements, which are more stringent than AICPA requirements for private company audits.

Minton warned, "A lot of people, companies, counsels, underwriters, want to make sure there is no speed bump on the road [to going public]... there could be no worse speed bump than an auditor [who] may have done prohibited services or bookkeeping, may have provided tax prep services, and prepared the tax footnote for the financial statements, common in private companies - prohibited in public companies." He added, "The PCAOB has a requirement, when an auditor is taking a PCAOB engagement, it must give a communication to the issuer at that time with matters that might affect independence; we have seen some issuers have ongoing auditors and don’t think they have to have that communication, and it is only near the end when bumped up to the National office that they realize they have these problems, from engaging a GAAS audit [under AICPA standards] to a PCAOB audit, you could have found that out in advance, planning is important… so you don’t have to find an auditor to audit the past three years financial statements."

On the flipside, for companies that are struggling in this economy, Minton reminded the group, "If you have a cash strapped client, you can’t use shares to pay your auditor, you can’t have any equity ownership in the client, if you think a company is going to lose their auditor by not paying fees, don’t pay [the auditor] in shares," as that violates the auditor independence rules.

Textron Case; IRS proposal: Minton very briefly reviewed some developments in the Textron case and mentioned a related IRS proposal that was recently issued:

  • "The First Circuit ruled there was no work product protection for tax accrual workpapers... prepared for ... financial statements, not in [regard to] litigation."
  • "About a dozen industry groups, including the ABA [American Bar Association], and FEI, [Financial Executives International] have filed friend of the court briefs for the Supreme Court to pick it up." [NOTE: see our related blog post.]
  • "The IRS, just last week, released an announcement seeking comment on … having a schedule to corporate tax returns that would itemize items company has identified, when thinking about FIN 48 and preparing reserves, would have to itemize the various transactions that went into that reserve calculation." [NOTE: see our related blog post.]

Wayne Carnall, Chief Accountant, Division of Corporation Finance

Carnall reviewed recent items issued by Corp Fin, and noted updates to Corp Fin's Financial Reporting Manual will be issued quarterly.

Suggestion for responding to Corp Fin Comments on Filings: Carnall said it is in the mutual interest of the issuer and the SEC "to make the process as efficient and effective as possible." He noted, "If we get to a point where we say you need to revise your financial statements, lo and behold, the submission [from the company in response to the Corp Fin comment] changes dramatically, the response becomes far more comprehensive." He advised, "I encourage people to make your last comment letter, your first comment."

10-K Reminders: Items to consider include: Impairment of goodwill; Accounting for income taxes; Accounting for income taxes; Going Concern; Pension (assumptions, curtailments), Segment reporting, Other Than Temporary Impairment (OTTI), Materiality ('SAB 99' memos), and Venezuela currency issues (detailed below).

Venezuela currency issues:
Carnall said he has spent a "fair amount of time talking about recently, some issues in Venezuela," where there was "a perfect storm of events, a dual rate system a number of years, and as of January 1, 2010, as a result of accounting rules, they [Venezuela] become[s] a highly inflationary economy." Thus, he noted, "All transactions on December 31 that were measured in Bolivars, are now measured in U.S. dollars as of January 1." He continued, "Then, shortly after year-end, [Venezuela's] President Chavez announced a devaluation of the official currency, that cut it in half."

He added:"We have seen a number of companies issuing press releases," noting, "what has surprised us was lack of disclosure we had seen previously."

Referencing a Corp Fin workshop scheduled to take place at the PLI conference at the end of the day on Friday [in-person workshop, not webcast by PLI], Carnall said, "Craig [Olinger] will talk about this: We will expect companies to disclose a fair amount about this; while Venezuela may have been insignificant with respect to sales, some of the charges we have seen.. [appear] material... expect more disclosure, losses and currency fluctuations are by no means done [over] in Venezuela; look at the Caterpillar case, it is very similar."

Richard Sennett, Chief Accountant, Division of Investment Management
Sennett highlighted new rules on audit and internal control reports for certain investment managers that serve as custodian, or have affiliate that serves as custodian.

Jason Flemmons, Associate Chief Accountant, Division of Enforcement
Flemmons highlighted various cases in which issuers and auditors were charged with violating securities laws, including as relate to fraudulent financial reporting, and auditor independence.

More From SEC Speaks
The Accounting Panel covered above was just one panel from Day 1 of PLI's SEC Speaks conference. The webcast of the entire conference, including all panels, the Chairman's and the Commissioners' remarks, will be available on a CD on March 5 (or DVD on March 19) for those interested in the entire proceedings. Further info is available on PLI's website,

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financial spread betting said...

How do you think they will react to Germany's ban on short sales? Do you think they will follow suit? Causing a bit of a problem in Europe.

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