Friday, June 27, 2008

MOU - SE; Senate Confirms 3 To SEC

The Memorandum of Understanding (MOU) aimed at coordinating supervision and examination (MOU-SE?) of financial institutions, including investment banks, being worked out between the Federal Reserve and SEC, is reportedly close to being issued, according to recent comments of SEC Chairman Christopher Cox as cited in this article by Rachelle Younglai of Reuters. “’We are making good progress,’” Cox said on June 25 of his work with Federal Reserve Board Chairman Ben Bernanke in developing the MOU, as reported by Younglai. As to timing, Cox added, according to Younglai, “‘I don't think we'd be discussing it publicly at all if we didn't think that we were close to doing it. It's just a question of whether it's before or after the Fourth of July at this point.’”

However, earlier today (June 27) Sen. Chris Dodd (D-CT) and Sen. Richard Shelby (R-AL), Chairman and Ranking Member, respectively, of the Senate Banking Committee, sent a letter to Cox, Bernanke and U.S. Treasury Secretary Henry M. Paulson, recognizing the agencies’ efforts to streamline and improve regulation, but cautioning them: “Given the limited authority of the Fed and the SEC to regulate investment banks with primary dealer status, and Congress’s ultimate responsibility for formulating financial regulatory policy, we ask that no action regarding implementation of the MOU be taken before we can determine that it is in the best interests of our nation’s economy and the well being of its citizens.”

Meanwhile, support for coordinated supervision for all ‘systemically significant institutions,’ was offered by Citigroup CEO Vikram Pandit in his op-ed appearing in today’s Wall Street Journal, “Toward a Transparent Financial System.” Pandit says three principles are key: systemic oversight, a level playing field, and transparency. “Markets cannot clear without transparency,” he said, adding, “Transparency concerns can lead to illiquidity. Yet transparency is difficult to achieve.”

Pandit’s suggestions were far-reaching. In the area of accounting standards, he noted the need for “Global coherence and consistency," and called for “clear guidelines regarding off-balance-sheet instruments.” He added, “Accounting based on a mark-to-model has been severely tested by unobservable inputs intended to estimate the market. This has fed into difficult, far-reaching decisions that impacted capital and other factors as one misinformed trade set off a chain of similar trades.”

“This raises an important question," says Pandit. "Are there alternative accounting approaches we should apply, particularly in dysfunctional markets?”

An expedited review of accounting standards for valuation and off-balance sheet treatment is already underway at the IASB, FASB and SEC. As we have previously reported:

The IASB’s Expert Advisory Panel on valuation in inactive markets is one of the groups addressing questions about valuation in illiquid markets and will also address issues of consolidation of special purpose vehicles involved in securitizations.

FASB is addressing issues concerning QSPEs and other off balance sheet entities involved in securitizations in its upcoming revision to FIN 46R and FAS 140.

The SEC is holding a Fair Value Roundtable on July 9.

Senate Confirms Commissioners for SEC
In other SEC news, the Senate voted today (June 27) to confirm the three nominees for commissioner of the SEC, Dems Luis Aguilar and Elisse Walter, and Republican Troy Paredes, as noted in this article by Manu Raju in The Hill.

In a statement issued today, SEC Chairman Christopher Cox said, “The President and the Senate have given the SEC three outstanding Commissioners. I look forward to welcoming them to their important positions of leadership in the finest securities regulatory agency in the world.

The SEC has laid out an ambitious agenda to improve investor protection and financial markets regulation, and a full complement of Commissioners will help us achieve those important objectives."

As we near the end of June, remember our Do You Know Somebody offer to interview 2 new subscribers (and the current subscribers who refer them) who sign up for our blog by June 30.
We usually post this blog once a day; today’s post is a bit later than usual due to the FEI Staff Picnic, 2008, a fun-filled day complete with water balloon toss, piñata, and a kickball game. Our NJ office HQ staff was pleased to be joined this year by our Washington DC office staff, including Michelle Coleman, Manager, Business Development, Serena Dávila, Director, Technical Activities, and Matt Miller, Director of Tax and Economic Policy. (Miller’s membership in the World Adult Kickball Association (WAKA) may have helped Captain Rudy Katzenberger’s team win 6-4 in today’s FEI kickball match.) Katzenberger, Senior Accountant at FEI, and the entire Activities Team did a great job planning the event. Opening remarks were given by former FEI Chairman Jim Abel, who will serve as interim CEO and President of FEI beginning July 1, as FEI searches for a new President and CEO. As previously announced, FEI’s current President and CEO, Michael P. Cangemi, resigned effective June 30, after which he will continue in a role as senior advisor for FEI, with a focus on accounting policy issues and associated advisory councils. Read more about FEI here.

Wednesday, June 25, 2008

SEC Proposes Rules on Rating Agencies, Annuity Contracts, More

At its open commission meeting on June 25, the SEC voted to release for public comment rule proposals relating to credit rating agencies, regulation of certain annuity contracts, and foreign broker-dealers. Separately, the SEC agreed to adopt interpretive guidance and related rule amendments to streamline the rule filing process of Self Regulatory Organizations (SROs).

Credit Rating Agency Proposals Will Affect Rating Agencies, Issuers
The credit rating agency (CRA) proposal approved for release on June 25 was the third in a series of proposals relating to CRAs considered by the SEC this month. (See our coverage of the first two proposals, voted on at the June 11 meeting.)

As described in SEC Chairman Christopher Cox’ opening remarks on June 25. the third CRA proposal (actually, a set of proposals) is “focused on the way the Commission's own rules refer to and rely upon credit ratings.”

Cox summarized the objectives of the third set of CRA proposals, based on the SEC staff’s review of existing rules, recent events in the subprime and credit markets, and related recommendations of the Financial Stability Forum:

  • “[I]n some rules and forms, the reference [in SEC rules] to credit ratings isn't really necessary at all. In those cases, the proposed new rules would simply eliminate the reference.
  • “In other cases, the staff has found that there is value in the use of a credit rating, but that the current way ratings are incorporated in the particular rule or form should be changed. In these cases the proposed rules would clearly state the regulatory purpose we are seeking to achieve, and then permit reliance on a credit rating as one way to achieve that purpose.
  • “Finally, in just a few cases, the staff has concluded that the reference to a credit rating continues to be appropriate exactly as it is. In these cases, because there is no hazard of inducing undue reliance on the ratings by investors, the recommendation before us is to leave the rules as they are.”
Besides rule amendments proposed by the Division of Trading and Markets and Division of Investment Management (including as relate to money market funds), certain CRA-related amendments proposed by the Division of Corporation Finance (Corp Fin), relate to eligibility to use Form S-3, shelf offerings, and offerings of asset-backed securities, as summarized in this statement by Corp Fin’s Steven Hearne.

As noted in our subsequent coverage of the SEC’s June 11 meeting, issuers may have direct disclosure obligations under the CRA proposals approved at the June 11 meeting, in addition to having to provide certain information to the CRA or arranger (underwriter) to disclose. Potential additional disclosure obligations for issuers in the proposals considered on June 25 were noted in Hearne’s remarks as follows:

“[T]he release does not propose to amend the Commission's policy on security ratings, as it is currently outlined in Item 10(c) of Regulation S-K. Information on ratings is permitted under Item 10(c) and in that item the Commission recommends issuers consider additional disclosure regarding the ratings. The release requests comment as to whether the Commission should instead mandate this disclosure and whether additional information regarding any material limitations or qualifications on the rating and any related designation or other published evaluation of non-credit payment risks assigned by the credit rating agency with respect to the security would be valuable to investors.”

Narrows Exemption of Certain Annuity Contracts from Federal Securities Laws
In other rulemaking action on June 25, the SEC voted to release a proposed rule relating to annuity contracts that would clarify the status under the federal securities laws of indexed annuities, under which payments to the purchaser are dependent on the performance of a securities index. A ‘more likely than not’-based determination of payments under the contract is proposed to determine if such contracts offered by insurance companies will remain exempt from the securities laws, or be subject to the securities laws.

The SEC’s proposal would exempt insurance companies from filing reports under the Securities Exchange Act of 1934 with respect to indexed annuities and certain other securities registered under the Securities Act and regulated as insurance under state law. The proposed exemption would be subject to the existence of state regulation of the insurer’s financial condition and the absence of trading interest in the securities; additionally, the insurer would have to takes steps to ensure a trading market in the exempted annuity does not develop. Prospective treatment is proposed (applying to indexed annuities issued on or after the effective date of a final rule, if adopted) and the proposed effective date is 12 months after the final rule (if adopted) is published in the Federal Register.

Foreign Broker Dealers Operations Can Expand
Also at the June 25 meeting, the SEC voted to release proposed rule amendments to expand the ability of foreign broker dealers to operate in the U.S. One such amendment would expand the category of U.S. investors to whom foreign broker dealers could provide research reports to and interact with, changing the current requirement from “institutional investors that own or control greater than $100 million in total assets,” to “all registered investment companies, corporations, companies, or partnerships that own or invest on a discretionary basis $25 million or more, and natural persons who own or invest on a discretionary basis at least $25 million.”

Additional proposals, including a proposal to remove a ‘chaperone’ requirement, whereby foreign broker dealers are currently required to be ‘chaperoned’ by U.S. broker-dealer personnel on certain interactions with U.S. investors, are aimed at expanding the ability of foreign broker dealers to operate in the U.S. without triggering registration, reporting or other requirements under the securities laws.

Commissioner Atkins said, “I commend Chairman Cox for your leadership on these long overdue amendments,” noting he was particularly pleased the proposed expansion of eligible investors included covered institutions as well as natural persons.

“I have to admit,” he added, “if we ultimately adopt these proposals, I will miss the opportunity for cheap jokes like the chaperone rule affords.”

SRO Proposals Respond to Inspector General Findings
Not only were NRSROs on the agenda at SEC’s June 25 meeting, so were SROs, as the SEC voted to release proposed rules to streamline the SRO rule filing process. These rule changes would streamline processes followed by SROs, and by the SEC with respect to its own Notice and filing requirements of SRO rulemaking.

Chairman Cox noted in his remarks on the SRO proposals, that the SEC’s Office of the Inspector General (IG) found that, although a requirement states that the SEC approve or institute proceedings to disapprove an SRO rule proposal within 35 days of its publication (which can be expanded to 90 days in certain cases), “The IG found that, on average, it took the Commission 57 days to issue a notice of a rule filing submitted pursuant to Section 19(b)(2) of the Exchange Act. The IG also identified two proposed rule changes where the Commission took more than five months and more than eight months to publish notices. The IG also analyzed an audit sample of rule filings that had been open for more than a year. The IG found that, on average, these rule filings had been open for well over two years, with the longest having been open for four years.” [See: report of the Inspector General, March 2008.]

The issue of timeliness of the SRO filing process has been around for a while. Commissioner Atkins observed that when he previously served on the staff of former Chairman Arthur Levitt, Jr., “One of the first assignments I had from Chairman Levitt, back [in] 1993, was to look at the SRO filings [backlog],” and he found at the time “some were decades old.”

The guidance proposed on June 25, said Cox, “should encourage SROs to file greater numbers of rule changes for immediate effectiveness where appropriate.”He added, “Importantly, however, SROs should understand that, as the volume of such rule changes increases, so may the possibility that certain rule changes could be abrogated. Undoubtedly, many market participants affected by such rule changes might try to persuade the Commission that a rule change filed for immediate effectiveness should be abrogated and re-filed for full Commission review. In my view, this would be a healthy outcome and one fully contemplated by the framework established under the Exchange Act.”

Thus, Cox explained, “In anticipation of this change in the Commission's processes, the staff also has recommended that the Commission now consider any such abrogations directly. Accordingly, the staff has recommended removing the provision delegating this authority to the Division of Trading and Markets. This change would enhance the Commission's involvement in this area, where industry and Commission practice likely will undergo a period of rapid transition over the coming months and years. Once the Commission and industry have had a chance to adjust to the new process and it has become more routinized, the Commission could once again call on the staff to administer abrogations by delegation.”

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Tuesday, June 24, 2008

Audit Firm Litigation,Fin'l Info Released By Treasury, CAQ;Att'y-Client Priv. Bill Gains Support;FASB, Lawyers Meet on FAS 5

In a little noticed development, the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP) released information on the litigation exposure and other financial, governance and human resource information of the six largest audit firms. The information consists of 3 separate reports provided to ACAP earlier this year by the Center for Audit Quality (CAQ), affiliated with the AICPA. CAQ gathered the information from the audit firms for consistency, used a law firm to help organize the data, and provided detail in the aggregate, or in some cases, in the form of averages, to protect confidentiality of the individual firms. See “Reports of the Major Public Company Audit Firms to the Department of the Treasury Advisory Committee on the Auditing Profession” – which were posted via a link on ACAPs website posted June 16 under “Data Matrices.”

ACAP’s discussion during its open meetings on the topic of auditor liability was commented on by Jim Peterson in his blog, Re: Balance on Friday. Peterson, who formerly served as a senior in-house lawyer with a major accounting firm, and whose columns have appeared in the International Herald Tribune, Journal of Accountancy, and elsewhere, wrote: “Did anyone really think that the endless chatter about saving the system of privately-provided audits for large global companies would come to anything? If so, that fantasy was dispelled on June 3, in the closing minutes of the latest meeting of the U.S. Treasury’s Advisory Committee on the Auditing Profession – webcast here. In his summation, Co-Chairman Don Nicholaisen explicitly stated that, with an insubstantial exception, the Committee’s recommendations ‘do not address catastrophic risk’ of the loss of the Big Four.” See also our earlier coverage of the June 3 ACAP meeting (our June 9 blog post), and related analysis by Francine McKenna, author of the Re: The Auditors blog (and her earlier post here).

Attorney-Client Privilege Bill Gains Support
Lynnley Browning reported in yesterday’s New York Times, in her article, “Bill to Protect Companies in Inquiries Adds Support,” that, “Nearly three dozen former federal prosecutors have thrown their weight behind a Congressional bill intended to safeguard confidential communications between lawyers and their clients, a legal bedrock that has come under attack amid corporate fraud scandals.”

“The closely watched bill,” Browning continues, “would make it illegal for prosecutors and other federal enforcement officials, including those at the Securities and Exchange Commission, to demand that a company under investigation disclose confidential legal communications or risk being indicted — a corporate death knell.”

The bill in question is the Attorney-Client Privilege Protection Act of 2007, sponsored in the Senate by Senate Judiciary Chair Sen. Arlen Specter, (see related info here), with a similar bill sponsored in the House Committee on the Judiciary, chaired by Congressman John Conyers, Jr.
Dan Slater provided a link to the letter in his post in the Wall Street Journal Law Blogyesterday, along with a link to related info on the proposed legislation on the website of the National Association of Criminal Defense Lawyers.

See also info on the Association of Corporate Counsel website; ACC’s SVP and Corporate Counsel Susan Hackett was interviewed in Browning’s NYT article. We had the ‘privilege’ of interviewing Hackett and others in this article in Financial Executive Magazine Sept. 2006 (Note: the article predates issuance of DOJ’s “McNulty Memo” which superceded the Thompson Memo; however the proponents of the current bill before the House and Senate argue the McNulty Memo did not go far enough in addressing concerns about the erosion of attorney-client privilege in efforts by DOJ and the SEC (through policy described in its “Seaboard Memo”) to ‘give credit’ for ‘cooperation,’ including cooperating by means of waiving privilege.

FASB Meets With Legal Profession To Discuss Privilege, Other Issues in FAS 5 Amendments
FASB board member George Batavick told the 1,200 attendees on FASB’s Mid-Year Update webcast yesterday that FASB met with representatives of the legal profession last week to discuss certain matters relating to proposed amendments to FAS 5 on disclosures of loss contingencies. Batavick described it as a good discussion, adding the attorneys plan to provide FASB with “examples of loss contingencies, how they ended up on the balance sheet, what the delays were.”

FASB Director Russ Golden added, “We recognize changes may need to be made relating to the ‘treaty’ between the American Bar Association (ABA) and the AICPA relating to ….[privileged information and] the audit process.”

Here’s some info about FASB’s proposal, Disclosure of Certain Loss Contingencies: an amendment of [FAS 5] and [FAS 141R], as described on FASB’s webcast yesterday:

  • August 8 is the comment deadline on the proposal.
  • Proposed disclosures for loss contingencies include: Description of nature and risk of loss, factors likely to affect outcome, and most likely outcome, Amount of claim, Detailed reconciliation of changes, and disclosure of loss contingency if severe and expected to occur in one year. Golden said he expects the proposal to be ‘extremely controversial.”
  • A ‘prejudicial exception’ is included in the proposal, said Golden, to address concerns expressed by companies that such disclosures would be ‘prejudicial’ in impacting the ability of those companies to defend themselves in certain lawsuits. Golden explained the proposed ‘prejudicial exception’: “In the event the case is so unique, so significant, a company is unable to describe the nature of the risk and amount of claim without giving away … information, the company would not have to disclose that information.” However, he added there are those who believe the proposed prejudicial exception would not be in the best interests of financial reporting.
  • FASB plans to hold a roundtable and “perhaps do an academic study” to improve loss contingency disclosures, said Golden, “with hopes we can finalize [the standard] by the end of the year.”
A broad array of subjects was covered on the FASB’s Mid-Year Update, including recently issued standards and projects in process, as well as convergence projects under the FASB-IASB Memorandum of Understanding. An archived version of the webcast will be posted by FASB; see also our Detailed Summary of FASB’s Mid-Year Update (note: our detailed summary can only be downloaded by FEI members, see info on FEI membership).

As a reminder, our Do You Know Somebody offer holds till the end of June.

SEC Launches Disclosure Study; Advisory Committee To Be Formed

Earlier today (June 24) the SEC announced the kickoff of its “21st Century Disclosure Initiative,” to study how information is obtained by the SEC from public companies, mutual funds, brokers and other regulated entities, and how it is made available to, and used, by investors and the markets.

The study will be led by Dr. William (Bill) Lutz, professor emeritus at Rutgers University. Lutz played a major role in the SEC’s Plain English initiative in the 1990s.

Besides the SEC’s Plain English Handbook, which Lutz had a significant role in developing, he is the author of numerous books and articles on the importance of plain language disclosures and avoiding doublespeak. (Some examples of Lutz’ work which I found also include his “39 Steps to Writing in Plain English” posted in 2005 by the Plain Language Association INternational (PLAIN), and “Life Under the Chief Doublespeak Officer” posted on a website called which appears to be a collection of various writings by various authors.)

The aim of 21st Century Disclosure Initiative, said the SEC, is “to outline the attributes of the disclosure system for the future that incorporates technology, the new ways in which investors get their information, and recent developments in how companies compile and report the information in their SEC-mandated disclosures.”

Blueprint Will be Published; Advisory Committee Will Be Formed
“The internal study will produce, by the end of 2008, a blueprint for future Commission action to improve the usefulness and timeliness of disclosure for investors,” stated the SEC. Additionally, the blueprint will aim to “streamline and modernize the collection of disclosure from companies and regulated entities.”

An advisory committee will be formed as part of this initiative, noted the SEC.

‘Fundamental Rethinking’ of Financial Disclosure; I.T. Key
“The study will be a fundamental rethinking of financial disclosure,” said the SEC, “beginning with the basic purposes of disclosure from the perspective of investors and markets.”

Information Technology (I.T.) will be a key aspect of the study, as the SEC notes: “Essential to the study will be the determination of how to match the capabilities of today’s information technology with the SEC’s regulatory aims and the needs of investors.”

All Existing SEC Forms, Reporting Requirements To Be Reviewed
The scope of the 21st Century Disclosure Initiative study, says the SEC, will include a review of:

  • all existing SEC forms and reporting requirements,
  • the manner in which information is provided to the Commission,
  • with a special focus on needless redundancy.“
Additionally, the study will:

  • consider various alternative strategic approaches to acquiring and publishing disclosure information
  • consider ways that regulatory requirements for the collection of information might be tailored to get the best real-time distribution of financial and narrative disclosure to investors, and
  • examine how best to integrate public disclosure with the SEC’s proposed new post-EDGAR architecture for investor search, assembly, and comparison of data.

Friday, June 20, 2008

All's Fair, and 404:SEC Seeks Comment on Issues For Fair Value Roundtable;Adopts Final Rule Delaying Sarbox 404b for Small Cos

On Friday afternoon (June 20), the SEC announced that it adopted a final rule delaying the Sarbanes-Oxley Section 404(b) requirement for small public companies (i.e., ‘non-accelerated filers,’ generally defined as those with less than $75 million market cap) to have an external auditor perform and report on an audit of internal control. This means small co’s, which just this year had to file their first management report on internal control under Sarbox Section 404(a), will have an additional year (i.e., effective fiscal years ending on or after Dec. 15, 2009) to comply with Sarbox Section 404(b). Without the delay announced June 20, small co’s would have become subject to 404b in fiscal years ending on or after 12/15/08.

Additionally, the SEC said it received approval from the U.S. Office of Management and Budget (OMB) on June 19 “to proceed with data collection for a study of the costs and benefits of Section 404 implementation.” The cost-benefit study reportedly ‘commenced’ on Feb. 1, according to an earlier press release, but one step along the way apparently involved obtaining OMB approval, which is now in place.

Besides “focusing” the study on “the consequences for smaller companies and the effects of the Section 404 auditor attestation requirements,” the SEC notes the study will also “help determine whether the new management guidance on evaluating the internal controls over financial reporting issued by the Commission in June 2007 and the Public Company Accounting Oversight Board's (PCAOB) Auditing Standard No. 5 approved by the Commission in July 2007 are having the intended effect of facilitating more cost-effective internal control evaluations and audits of smaller reporting companies.” Additionally,”The study includes gathering new data from a broad array of companies about the costs and benefits of compliance with the Section 404 requirements. The study also pays special attention to those smaller companies that are complying for the first time with the requirements that are currently in effect.”

Some will criticize the delay, noting 404 has been around for years now, and small co’s have had ample time to get on board. However, others – like NYSE Euronext CEO Duncan Niederauer – are calling for a ‘rationalization’ of Sarbox for small co’s, and the breather allowed by this delay will enable the SEC and others to take a look at some objective (and subjective) data about cost-benefit obtained through the SEC’s study.

In other Friday afternoon news emanating from 100 F Street … the SEC announced it invites comment on the following issues to be addressed at its July 9 roundtable on fair value measurement:

  • the usefulness of fair value accounting to investors
  • potential market behavior effects from fair value accounting
  • practical experience and potential challenges in applying fair value accounting standards
  • aspects of the current standards, if any, that can be improved
  • experience with auditors providing assurance regarding fair value accounting
A final agenda and list of participants and moderators for the roundtable will be announced at a later date.

We’ve covered fair value accounting issues extensively in this blog over the past year, particularly as relate to subprime securitizations and the credit market crisis. Links to some of our past coverage can be found in the FASB and IASB sections of our June 19 blog post.

Do You Know Somebody...

… who would like to receive this blog? If so, please pass this on to them. In appreciation, we’ll pick 2 new subscribers who sign up between now and June 30 - and the 2 subscribers who referred them, to interview you/them for the blog. However, if you/they prefer to remain anonymous, we’ll offer the option of interviewing someone else at your/their company/organization - or at an unrelated organization of your choice - if you have a contact there who would like to be interviewed. You/they can speak to us about any topic of interest relating to this blog, within reason (we get to set the parameters of what constitutes ‘within reason.’) So if you like our blog, please pass the word to friends/colleagues, and let them know they can sign up for the blog here. Thanks. We now return to our regularly scheduled programming…

…. And, just what is our regularly scheduled programming? Typically, we cover happenings at the FASB, IASB, SEC, PCAOB, and the U.S. Treasury Department - as relates to financial reporting. (Occasionally, we flavor the alphabet soup with news from the IRS or DOJ.) So, in that order, here’s a roundup of recent news:

FASB will webcast a mid-year update on Monday June 23 at 2pm EDT, to discuss, among other things, their upcoming amendments to standards on securitization and off-balance sheet entities (FIN 46R and FAS 140), including removing Qualified Special Purpose Entities (QSPEs) from the literature. Some of the amendments have been in the works for a couple of years, others have been accelerated in light of the subprime crisis and related credit market turmoil, which prompted the President’s Working Group and the SEC to ask FASB to readdress these standards this year. See some of our previous coverage of these issues here, here, here, here, here, here and here.

The IASB held a roundtable on its Constitutional Review on June 19. Bolstering governance and funding of the IASB and the International Accounting Standards Committee Foundation (IASCF) which oversees it, is a priority not only in the U.S. – which is considering moving from U.S. Generally Accepted Accounting Principles (U.S. GAAP) published by the FASB, to International Financial Reporting Standards (IFRS) published by the IASB, but also a priority to European and other regulators worldwide who are seeking a formal level of accountability from the IASB, given what amounts to the IASB’s quasi-legislative role in issuing standards that are required to be adopted (in over 100 countries now) by virtue of the European Union’s and other countries’ requirements that listed companies in their jurisdiction adopt IFRS. Earlier this week, you may have seen the joint statement issued by the SEC, European Union and Japan FSA, supporting IASCF’s proposed formation of an IASCF Monitoring Group, consisting of reps from those regulatory agencies as well as reps from IOSCO and the World Bank.

But – did you know the IASCF is also considering breaking their tradition of avoiding geographic ‘quotas’ for IASB board members, and instead is considering expanding the current 14 member IASB board to 16 members, adding an explicit geographic requirement of 4 IASB board members from North America (Canada has already formally announced it is in process of moving to IFRS), 4 from Europe, 4 from the Asia/Oceana region, and 4 others from any region. Increasing North American representation on the IASB may help pave the way for the SEC to permit- or require – adoption of IFRS in the U.S. for public companies, and may also help smooth the way for private company adoption of IFRS. Details of proposals discussed in the IASCF’s Constitution Review are in this draft Discussion Document (aka issues and proposals), which indicates it is on the road toward being published for public comment, with a comment deadline tentatively falling in September. See also our coverage of this week’s FASB’s Forum on High Quality Global Accounting Standards, including expectations regarding SEC’s upcoming ‘IFRS Roadmap,’ here.

Other significant news from the IASB this week includes the announcement of release of a summary of the June 13 closed door meeting of IASB’s Expert Advisory Panel on Valuation of Financial Instruments in Inactive Markets. The IASB was asked to address these matters and others by the G-7 Group of Finance Ministers, who not only endorsed (in April) related recommendations of the Financial Stability Forum (FSF), but asked that certain actions be taken within 100 days, as we previously noted here.

SEC: continuing on the topic of Fair Value for a moment, we previously reported (citing a WSJ interview of the SEC Chairman) that the SEC plans to hold a roundtable on fair value measurement issues in July. More recently, an article published by BNA on June 2, ("SEC Officials Defend Fair Value Rules in Credit Crisis, Say Investors Better Served") citing remarks by SEC Chief Accountant Conrad Hewitt and Deputy Chief Accountant Jim Kroeker at a USC conference, noted the SEC's fair value roundtable was planned for July 8.

On the rulemaking front, next week, the SEC will hold the second of two open meetings on proposed rulemaking regarding Credit Rating Agencies (CRAs). See the Sunshine Act Notice published by the SEC in advance of next week’s meeting, and see our previous coverage of CRA rule proposals discussed at SEC’s June 11 meeting here and here.

Of course, today’s front page news “2 Face Fraud Charges in Bear Stearns Debacle” (NYT), “Former Fund Managers Face Fraud Charges in Credit Crisis” (WashPost) – and, in the case of the Wall Street Journal, page C-1 news: “Two Ex-Managers at Bear Indicted Over Hedge Funds,” and “Youz Indictin’ Who? A Rivalry Grows For Stock Cops in Brooklyn, Manhattan,” covers the arrest yesterday of former Bear Stearns managers Ralph Cioffi and Matthew Tannin.
The two were charged with conspiracy, securities fraud and wire fraud, as noted in this DOJ press release. Among actions cited leading to their arrest are emails noting concern about prospects for hedge funds that later tanked, as well as alleged false information they gave the public about their own personal investments in the funds, while touting the funds to increase investor confidence. The SEC concurrently brought charges yesterday against Tannin and Cioffe, as noted in this SEC press release. The Bear Stearns hedge fund crisis, which arose about a year ago, was one of the first major markers (to the broad public, at least) of the broader subprime crisis. See our earlier reporting on Bear Stearns here and here.

In other SEC news… SEC Chairman Christopher Cox published an op-ed in the WSJ yesterday, entitled, “A Brave New World for Financial Regulation,” in which he describes the Federal Reserve guaranteed bailout of Bear Stearns following the ‘run on the bank’ the firm experienced and the related opening of the Fed’s discount window to investment banks to prop up liquidity. As to the SEC’s role, he notes: “SEC regulation was supposed to protect the broker-dealer's customers, which it did.” Although he does not go into a technical discussion of SEC’s role in supervising investment banks under the SEC’s Consolidated Supervised Entities (CSEs) program, he observes that Bear Stearns’ capital level, had it been a commercial bank, would have been deemed ‘well capitalized.’ However, he notes additional protections available to commercial banks in times of crisis were not available to investment banks like Bear Stearns.

As a result, Cox notes, “It is clear that these protections are no longer enough…. Should the extensive system of commercial banking supervision and regulation, developed in large measure to counter the problem of moral hazard, be extended to investment banks? If so, who should be responsible for it?”

“In my judgment, explicit legislative authorization for what is now a purely voluntary program of SEC supervision is vital,” adds Cox, “But even if legislation is not forthcoming, the arrangements being worked out by the SEC and the Fed can serve as a sturdy approach for the indefinite future.”

Cox’ op-ed may have been a run-up to the remarks of U.S. Treasury Secretary Henry Paulson, in a speech Paulson gave yesterday, in which he gave an update on the economy and focused on the need to accelerate discussions on Treasury’s Blueprint for regulatory reform issued earlier this year. Some had viewed the blueprint as potentially reducing the SEC’s and certain banking agencies authority while increasing the Fed’s authority as coordinator of financial market supervision. Cox stated in his oped, “maintaining the diverse perspectives of the Fed and the SEC, within a consultative process, is exceptionally useful.” See our prior coverage of Treasury’s Blueprint here.

Separately, we wanted to remind you that the comment deadline on updated subcommittee reports of SEC’s Advisory Committee on Improvements to Financial Reporting (CIFiR) is June 23, and the comment deadline on the U.S. Treasury Department’s Advisory Committee on the Auditing Profession (ACAP) Draft Report was June 13, with a deadline of July 9 on the Addendum to its Draft Report. See some examples of our previous coverage of CIFiR and ACAP here and here.

PCAOB finalized rules recently (now pending SEC approval) on annual and special reporting of certain information concerning the audit firm and certain events in reports to be filed with the PCAOB. See our related coverage here.

Coming up: the PCAOB announced yesterday the names of panelists that will take part in PCAOB’s June 25 roundtable discussion on: “a proposal regarding the circumstances in which it could maximize its reliance under Rule 4012 on non-U.S. auditor oversight bodies in the context of inspections.”

Wednesday, June 18, 2008

NYSE Euronext CEO Calls For 'Rationalizing' Sarbox For Small Cos; SEC Action Pending; Update on PCAOB Constitutional Challenge

In remarks at the National Press Club (NPC) yesterday (June 17), NYSE Euronext CEO Duncan Niederauer is reported to have said that “Congress should relax the Sarbanes-Oxley Act for small and medium-size companies because it discourages them from listing on U.S. stock exchanges,” as reported by Neil Roland of Financial Week (FW) in his article, “NYSE CEO calls for relaxation of Sarbanes-Oxley for small and mid-size companies.
Niederauer is also quoted in a Reuters article by Rachelle Younglai and Phil Wahba, “NYSE Euronext CEO urges Sarbanes-Oxley rethinking,” as having said: “We should think about ways to rationalize Sarbanes-Oxley, particularly for the small and medium-size enterprises."
Neither article indicated that Niederauer called for any 'exemptions.’ However, FW writer Roland adds, “An investor group opposes the NYSE’s efforts,” citing Council of Institutional Investors (CII) Deputy Director Amy Borrus as having said, "We believe that all companies that tap the capital markets should have to play by the same rules, and we’re disappointed with the SEC exemptions."
Reuters’ Younglai and Wahba added: "Regulators have already taken steps to help cut costs to comply with the Sarbanes-Oxley corporate reform law, which has been blamed for driving business away from the United States. Niederauer said it wasn't only Sarbanes-Oxley, but also the litigious nature of the United States and the fact that most countries use international accounting standards while the United States uses its own set of globally accepted accounting standards." [In related news, see our post on FASB’s Forum on High Quality Global Accounting Standards, held earlier this week.]
If Niederauer’s remarks at the NPC yesterday are posted, we will provide a link.
SEC Action PendingThe SEC has not yet acted to finalize its proposed rule released Feb. 1, that would delay the Sarbanes-Oxley Section 404b auditor attestation on internal control for small co's, i.e. "nonaccelerated filers" - co's with less than $75 million market cap – to fiscal years ending on or after Dec. 15, 2009. Without the proposed extension, small co’s would need to provide an auditor’s attestation on internal control (technically, for their auditors to provide an ‘integrated audit’ of the financial statements and an audit of internal control, instead of just an audit of the financial statements beginning this year (fiscal years ending on or after Dec. 15, 2008), under existing extensions passed previously by the SEC in Dec., 2006. Under the Dec. 2006 extensions, small co’s came under the Sarbox Section 404a management report umbrella already (fiscal years ending on or after Dec. 15, 2007, 10-Ks filed this year). When the SEC announced the proposed delay of the 404b internal control audit requirement for small co’s on Feb. 1, they noted they wanted more time to study ‘real world data’ on the cost-benefit of Sarbanes-Oxley 404 reporting, under a study launched that day, led by SEC’s Office of Economic Analysis (OEA).
Separately, we previously reported on the April 30 release of the results of FEI’s 7th Sarbanes-Oxley Section 404 cost-benefit survey, which found: a decrease in total cost of compliance with Section 404, an increased sense of benefits from Section 404 (enhanced investor confidence in financial reporting, enhanced reliability of financial reporting, and enhanced ability to prevent and detect fraud), a 5.4% decrease in audit fees attributable to the Section 404 portion of the integrated audit, and a 1.8% increase in total audit fees (i.e., for the integrated financial statement audit and internal control audit).

Update on PCAOB Constitutional Challenge
If you are following Sarbanes-Oxley related doings, for an update on a lawsuit filed by audit firm Beckstead and Watts, LLP in conjunction with the Free Enterprise Fund, backed by a legal team including former Special Prosecutor Kenneth Starr, challenging the constitutionality of the PCAOB, see the recent post by Dave Lynn in blog. Lynn comments on developments at a recent hearing in the DC Circuit Court of Appeals on this case, and observes: “While it is certainly difficult to tell solely from the oral argument, this case may not be a slam dunk for the PCAOB and the government. Certainly the consequences of a ruling against the PCAOB are difficult to imagine - reopening the PCAOB and all of Sarbanes-Oxley at this point would undoubtedly be a bad idea.”
Similar sentiments were expressed in an article by Bloomberg’s Jon Weil cited by Lynn, in which Weil noted, “if Congress attempted to change this one part of Sarbanes-Oxley, it could wind up re-opening the entire act for debate, giving corporate lobbyists a new shot at gutting other provisions aimed at strengthening companies' audits and governance.

In a statement issued on June 2, Brad Beckstead, Managing Partner, Beckstead and Watts, LLP said: “My legal team and I are encouraged by the recent presentation of our case to the Appeals Court. The presentation went very well. We are confident in a successful case!”

Beckstead added, “I encourage Congress and the SEC to take action now to remove the 'barriers to entry' to US capital markets for small and developing companies by exempting micro and small-cap public companies and smaller audit firms from the regulatory oversight of the Sarbanes-Oxley Act of 2002."

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Monday, June 16, 2008

SEC's Hewitt, At FASB Forum, Amplifies Cox' Remarks On IFRS Rulemaking Coming This Summer;FEI Supports Global Stds, Forms CRIFR

SEC Chief Accountant Conrad Hewitt, speaking earlier today at FASB’s Forum on High Quality Global Accounting Standards, further amplified the status of SEC’s upcoming “IFRS Roadmap,” following on direct remarks on this topic by SEC Chairman Christopher Cox last week.
As background, in a speech at a CFA Institute conference last week, Cox said: “You have offered helpful insights on our Concept Release on whether, and under what circumstances, U.S. issuers should be allowed to prepare their financial statements using IFRS. That's a vitally important topic the Commission is scheduled to take up in the form of a proposed rulemaking later this summer."

At FASB's forum earlier today, SEC Chief Accountant Conrad Hewitt quoted Cox' statement above, and further clarified the SEC’s plan with respect to the IFRS roadmap.

Hewitt said: “We are working on that roadmap, if you think about a roadmap, every roadmap has a starting point, an ending point, origination, destination, within a given timeframe. The [IFRS] Roadmap concerns whether US companies should have the option to use IFRS."
Hewitt continued, “A roadmap should have milestones or benchmarks to guide the SEC to future decision to mandating IFRS.” He then detailed a list of milestones, including as relates to IASB governance and independence.

My personal take on Cox and Hewitt’s remarks, when looked at in combination, is: The SEC’s proposed IFRS roadmap may include the concurrent release of proposed rulemaking that would permit U.S. companies the option of reporting in IFRS instead of U.S. GAAP. (that is based mainly on Cox' comments above). I believe the accompanying roadmap will then include additional milestones which the SEC will want to see before it mandates IFRS for all, or a subset, of U.S. public companies, (based on Hewitt's comments cited above), including such issues as enhanced governance, funding, and independence of the IASB. The one linking concept I am not sure about is whether those companies electing optional IFRS adoption would be given a date certain by which they would have to adopt IFRS, or if the date certain would be more a ‘destination’ to be confirmed down the road after certain milestones on the long-term (3-5 year) roadmap are achieved.

FEI Supports High Quality Standards Promulgated by IASB; Forms Corporate Roundtable on International Financial Reporting

FEI President and CEO Michael P. Cangemi, speaking at today’s FASB Forum, noted that “FEI has been on the record supporting high quality international standards promulgated by the IASB.” He added “We were for the elimination of the reconciliation,” and, “we look forward to continuation of the debate, and applaud FASB for setting up the roundtable today.”
Half of FEI’s membership of senior financial executives work for public companies, and half work for private companies. In addition to addressing public company issues, Cangemi noted he looked forward to the discussion of private company issues that would take place during the afternoon sesson of FASB's Forum. (FASB board member Leslie Seidman, during opening remarks at todays' program, noted the morning session would focus on public companies, the afternoon session expanding to private company issues as well.)

Cangemi noted that the views of FEI’s public company members on IFRS are somewhat bifurcated, based on the size of companies and whether they have global operations. However he noted there is a shared interest in moving to one set of global standards.

Recognizing that not all companies have precisely the same view or state of readiness, Cangemi noted that at this time, “Our members, especially public companies, believe there should be a period during which there could be an option for our U.S. companies to use IFRS. We also see a big need for increased awareness." Noting FEI has sponsored two conferences on IFRS over the past year, he said a sign of increased awareness and interest in the subject was the fact that the most recent conference (last week) was sold out. Further details on FEI views can be seen in the comment letter filed by FEI's Committee on Corporate Reporting (CCR) on SEC's Concept Release last fall.

Additionally, as noted by Cangemi, FEI recently announced the formation of the Corporate Roundtable on International Financial Reporting (CFIFR), with charter members including FEI, Honeywell Corporation, Eli Lilly Company, and others. FEI is “hoping to expand the discussion and debate by inviting companies to join this broad based initiative, said Cangemi.

You can listen to the live webcast of the FASB forum, which is taking place right now, continuing through 4pm today.

[UPDATE: Additional details on the public company discussion can be found in this FEI summary, and details on the afternoon's private company discusison and closing remarks can be found in this FEI summary. (Note: summaries downloadable by FEI members only, see info on FEI membership.)] If you received this blog post from 'a friend' and would like to receive the blog directly by email, sign up here.

Friday, June 13, 2008

What Issuers Need To Know About SEC Credit Rating Agencies Proposal, FASB Securitization Proposals

Issuers, not only credit rating agencies (CRAs), may have new, direct disclosure obligations under the CRA-related rule proposals approved for release by the SEC earlier this week. These direct disclosure obligations would be in addition to providing information to CRAs and arrangers (underwriters) to meet their disclosure obligations.

The issuer disclosure requirement may be below the radar screen right now (prior to the proposal reaching the street), since issuers and others may have assumed, based on advance press linking the SEC’s then-anticipated proposals to similar proposals for ‘credit rating agency reform’ developed by the New York State Attorney General, that the proposals would impact how CRAs conduct their business and a presumption that related disclosures would be required of CRAs only. A similar message as to scope was implied in the SEC’s agenda which stated, “The Commission will consider whether to propose rules relating to Nationally Recognized Statistical Rating Organizations [NRSROs],” and the Sunshine Act notice which was identical, except for an added reference to “and credit ratings.”

And, virtually all the bullets citing specific requirements of the proposal in the SEC’s press release and in SEC Chairman Christopher Cox’ opening statement specify the scope of the proposals would “require CRAs to …” or “prohibit CRAs from ….”

But, issuers should look closely at the bullet in the press release (and in Cox’ opening statement) which says:

“Require the public disclosure of the information a credit rating agency uses to determine a rating on a structured product, including information on the underlying assets. That would permit broad market scrutiny, as well as competitive analysis by other rating agencies that are not paid by the issuer to rate the product.”

Notice that bullet does not say “require CRAs to disclose,” just that someone is obligated to provide “public disclosure” of certain information relating to the rated issue, including the underlying assets.

Commissioner Paul S. Atkins raised a related question during the open meeting (archived webcast available), asking, “The issuer/arranger will be making the disclosures. How will they know what information the NRSRO is using in its rating?”

SEC staffer Randall Roy of the Division of Trading and Markets responded to Atkins, “The NRSRO itself would have to come to agreement with the arranger, this is information I am going to use, before I issue my rating, you need to make sure that it is publicly available.”

We previously reported some highlights from the open commission meeting, but we wanted to flag the above point for issuers today so they don’t miss it before beginning summer vacations, since the comment deadline on the SEC’s CRA proposal will be 30 days (30 days from date the proposal is published in the Federal Register).

As always, reference should be made to the proposals when posted by the SEC, for the specifics on who will be required to do what. [UPDATE: The SEC's rule proposal was posted on the SEC website 6.16.08.]

FASB Proposals To Amend Securitization, Off-Balance Sheet Rules To Be Effective Jan. 1, 2009; Existing QSPEs to be Grandfathered One Year
Issuers (and others) will also be interested in the proposed effective date for FASB’s upcoming amendments to FIN 46 R and FAS 140 impacting securitizations and off-balance sheet treatment for certain sales and transfers of assets.

As we previously reported, among the amendments to be proposed include the removal of the Qualified Special Purpose Entity (QSPE) concept – a structure which FASB literature had presumed - and required - to be ‘passive’ (i.e. not actively managed) in order to receive and retain sale treatment.

The requirement for the QSPE to remain ‘passive’ became problematic during the subprime crisis, as it was seen as a barrier to the ability of lenders, servicers and investors to agree to modify the terms of such mortgages, even when called upon to do so by the U.S. Treasury Department, members of Congress, and others. (We covered related correspondence on this point last summer from Rep. Barney Frank, Chair of the House Financial Services Committee, to SEC Chairman Christopher Cox, Chairman Cox’ response, and correspondence from the SEC Chief Accountant earlier this year to FEI and the AICPA relating to permissibility of continued sale treatment for loan modifications under the American Securitization Forum’s standards. That letter noted the SEC had asked FASB to consider amending its standards by year-end.)

At its board meeting earlier this week, FASB agreed that for reporting purposes, the effective date of the upcoming amended standards (FIN 46R, FAS 140) would be fiscal years beginning after 11/15/2008, and interim periods in those fiscal years.

In addition, based on discussion at the board meeting:

  • the FIN 46R amendments would apply to all new entities after 1/1/09, and to all items under the existing scope of FIN 46R as of 1/1/09.
  • the FAS 140 amendments would apply to all new transfers after 1/1/09.
  • QSPEs in existence prior to 1/1/09 -since they will no longer be scoped out of the amended FIN 46R, would be grandfathered for one year (to 1/1/10).
Additionally, FASB will propose ‘transition disclosures’ that would be required in the event they are not able to finalize the full amendments in time to become effective 1/1/09 (fiscal year-end 11/15/08 reporting). [See also FEI summary of decisions reached at the June 4 FASB board meeting re: FIN 46R and FAS 140; summary downloadable by FEI members only, see info on FEI membership. Additional matters decided at the June 11 FASB board meeting were reported on in BNA's Daily Report for Executives.] The above info is based on my listening to the webcast of the June 11 FASB meeting; official results of FASB meetings are reported in FASB’s Action Alert and board minutes.

As a reminder, FASB’s forum (webcast) on “High-Quality Global Accounting Standards: Issues and Implications for U.S. Financial Reporting” will take place from 9:00 am – 4:00 pm on Mon. June 16. FEI President and CEO Michael P. Cangemi and FEI member Andy Thrower (a member of FASB’s Small Business Advisory Committee and a member of FEI’s Committee on Private Companies – Standards Subcommittee) are among those appearing on the panel. Judy O'Dell, chair of the FASB-AICPA Private Company Financial Reporting Committee will also participate, as will a host of panelists from government and private sector organizations, listed here.

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Wednesday, June 11, 2008

SEC Approves Release of Two Proposed Rules On Credit Ratings, Credit Rating Agencies; Third Proposal To Be Considered June 25

At its open commission meeting this morning (June 11), the SEC voted to release two proposed rules relating to credit ratings and credit rating agencies. A third proposed rule will be considered on June 25. Chairman Christopher Cox, Commissioner Paul Atkins, and Commissioner Kathleen Casey unanimously agreed on the first proposal, Atkins dissented from the second. Here is the SEC's press release, some highlights of the meeting based on listening to the webcast are provided below.
As detailed in Chairman Cox’ opening statement, the proposals “would regulate the conflicts of interests, disclosures, internal policies, and business practices of credit rating agencies.” He added that although the proposals are largely the work of the SEC's Division of Trading and Markets, they “reflec[t] the input of several of the Commission's … Divisions and Offices, as well as a number of international regulatory organizations that have studied these issues, including the Financial Stability Forum and the International Organization of Securities Commissions [IOSCO].”
The first proposal approved for release today would, among other things:
Prohibit a credit rating agency (CRA) from structuring the same products that they rate,
prohibit CRAs from rating structured products unless information on assets underlying the product were available,
require disclosure by CRAs of the way they rely on the due diligence of others to verify the assets underlying a structured product,
require credit rating agencies to make an annual report of the number of ratings actions they took in each ratings class, and
require the maintenance of an XBRL database of all rating actions on the CRA’s website.
The second proposal approved today (with a 2-1 vote, Atkins dissenting) would require credit rating agencies (CRAs) to differentiate the ratings they issue on structured products from those they issue on bonds, either through:
· the use of different symbols, such as attaching an identifier to the rating, or
· by issuing a report disclosing the differences between ratings of structured products and other securities. The report would have to be issued by the CRA each time it publishes a credit rating for a structured finance product, and would be required to describe:
o the rating methodology used to determine the credit rating and how it differs from the determination of a rating for any other type of obligor or debt security, and
o how the credit risk characteristics associated with a structured finance product differ from those of any other type of obligor or debt security.

Atkins explained his dissent from the second proposal, referred to informally as the ‘symbology’ proposal due to its option of providing a new rating symbol for structured finance products. He noted the fact that structured finance products differ from other securities “ought not to come as a revelation” to investors in those products, who tend to be institutional (sophisticated) investors, and although ‘the scarlet letter’ of ‘the dreaded SF ratings” (for Structured Finance) may go away, he observed “the tenuous benefits of the proposal could come with quite a cost,” and additionally, he questioned f some parties would find a way to essentially structure around the process to avoid the SF rating.

In terms of cost, Atkins noted not only direct costs incurred by CRAs, but also costs to the economy arising from the fact that certain institutional investors (e.g. insurance companies, pension funds) may be prohibited from investing in other than certain classes (ratings) of securities. Thus, if the ‘-SF’ - or ‘Dot-SF’ designation, as Atkins referred to it - is not among the permitted ratings designations for some institutional investors’ investment portfolios, unintended economic consequences could include potentially forcing those institutions to liquidate those prohibited holdings from their portfolios, thereby depressing the market further for those securities. He noted federal and state regulators and others could amend their rules (and presumably funds would need to amend their governing documents) to account for the new ratings symbols, but those amendments could take time and be costly.

“The major underlying question for me,” said Atkins, “is whether we have the underlying authority,” to require this change in symbology. Referencing the basis for that section of the proposal, he added, “the constructed books and records bootstrap seems tenuous at best, it is clear under [the Credit Rating Agencies Reform Act] that we not micromanage the ratings process, particularly where some ratings agencies see symbols as a proprietary matter.”

The third proposal to be considered at SEC’s June 25 meeting, said Cox, will address: “To the extent that the SEC’s references to credit ratings in our rules are viewed by the marketplace as giving credit ratings an implied official seal of approval, [some have argued that] our own rules may be contributing to an uncritical reliance on credit ratings as a substitute for independent evaluation.”

In anticipation of the June 25 meeting, Commissioner Atkins noted there would be “a real benefit in removing the government imprimatur” implied in the SEC’s current rules with respect to credit ratings.

Commissioner Casey concurred that it is “vital that market participants and regulators do not put undue reliance on these ratings.” Although she voted with Chairman Cox to release the proposed rule on ‘symbology’ (option of new symbols or reports), to get constituents’ input through the comment period, she cautioned against adding what may be ‘largely symbolic gestures’ that may add cost and unintended consequences.

Additional details from today’s SEC meeting can be found in this FEI summary. (Summary can only be downloaded by FEI members, see info on FEI membership.)

Tuesday, June 10, 2008

PCAOB Board Votes To Adopt Final Rules on Annual and Special Reporting By Audit Firms; Next Step Is SEC Approval

Earlier today, the PCAOB board approved final rules to require certain information be provided in annual and special reports to be filed by audit firms that are registered with the PCAOB (referred to generically below as 'audit firms.') The rule approved today follows from a rule proposal released for comment in 2006, and will require:

Annual reporting by audit firms (PCAOB Form 2): Each audit firm must annually provide basic information about the firm and the firm's issuer-related practice over the most recent 12-month period. Information to be reported annually includes, among other things, information about audit reports issued by the firm during the year, certain disciplinary history information about persons who have joined the firm, and information about fees billed to issuer audit clients, in various categories of services, as a percentage of the firm’s total fees billed. (Note: As previously reported, the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP) is considering recommendations on audit firm 'transparency,' including potentially requiring additional disclosures about an audit firms' financial position and audit quality indicators. Those considerations go beyond the information included in the final rule approved by the PCAOB today.)

Special reporting by audit firms (PCAOB Form 3): The rules and forms adopted by the Board identify certain events that, if they occur with respect to a registered firm, must be reported by the firm within 30 days. These reportable events range from such things as a change in the firm’s name or contact information to the institution of certain types of legal, administrative, or disciplinary proceedings against a firm or certain categories of individuals.

ISSUERS NOTE: Among the list of ‘reportable events’ in the final rule which trigger special reporting by audit firms to the PCAOB, carrying forward from the proposed rule, is if the audit firm has withdrawn an audit report on financial statements, and the issuer failed to comply with related SEC reporting requirements (Item 4.02 of Commission Form 8-K) concerning the matter.

Publicly available: The audit firms’ annual and special reports will be available to the public on the PCAOB’s website, subject to exceptions for information that satisfies specified criteria for confidential treatment.

SEC approval required: As is the case for all PCAOB rules, the PCAOB will submit the rules to the SEC for approval.

Effective date: The rules will take effect 60 days after SEC approval. Beginning then, audit firms
will be subject to the special reporting obligations, with the earliest potential special reporting deadline for any firm being 90 days after Commission approval. For all audit firms, the first annual report will be due by June 30, 2009, for the 12-month period ending March 31, 2009.

Further guidance: The PCAOB plans to publish guidance for audit firms relating to compliance with the reporting equirements and interaction with the PCAOB's new Web-based system for reporting. Steven B. Harris, PCAOB's new board member: Participating in his first public board meeting today was the PCAOB's newest board member, Steven B. Harris. Harris was appointed to the PCAOB on June 4, as noted in this SEC press release, and in these statements welcoming Harris issued by PCAOB board chairman Mark Olson and PCAOB board members Dan Goelzer, Bill Gradison, and Charles Niemeier. Harris fills the board position formerly held by Kayla Gillan, who is now with RiskMetrics. Formerly serving as Staff Director and Chief Counsel of the Senate Banking Committee, Harris was there when the Sarbanes-Oxley Act was drafted which created the PCAOB. For an interesting discussion of regulatory appointments of former Hill staff, see the subsection entitled "The PCAOB's Newest Board Member: A History Lesson" in this post by Broc Romanek in blog.

Links: Additional details on the final rules approved by the PCAOB today are in the PCAOB’s press release. Update: The final rule has been posted on the PCAOB website: Rules on Periodic Reporting by Registered Public Accounting Firms. As noted above, the final rule is still subject to SEC approval.

Regulators, Financial Inst. To Enhance Infrastructure for OTC Deriv Trading; FASB Issues Prop Amend to Hedging Std

A group of major financial market participants, industry groups and regulators agreed at a meeting at the Federal Reserve Bank of New York (NY Fed) yesterday to certain steps to improve the infrastructure of OTC Derivatives trading, including to reduce counterparty risk.

The steps are listed in this Statement released by the NY Fed, and detailed further in this speech by Timothy F. Geithner, President of the NY Fed. These improvements follow on a request made by the Presidents Working Group on Financial Markets.

In related news on the Derivatives front, FASB released for public comment last week an Exposure Draft of a proposed amendment to FAS 133, "Accounting for Hedging Activities." The comment period ends August 15.

Separately, FASB released another Exposure Draft last week, “Disclosure of Certain Loss Contingencies,” which would amend FAS 5 “Accounting for Contingencies,” and certain portions of FAS 141R “Business Combinations.” The comment deadline is August 8.

Monday, June 9, 2008

Euro. Comm. Recommends Limiting Auditor Liability; U.S. Treasury ACAP Debates Liability; Publishing Addendum For Comment

On June 6, 2008, the European Commission published a recommendation calling for EU Member States to develop liability caps for auditors, or permit listed companies to develop such caps in consultation with their shareholders and governing boards, subject to judicial review and disclosure. These caps would pertain to statutory audits of listed companies.

As noted in an article by Jennifer Hughes in the June 7 Financial Times, "EU Calls For Limits to Auditors' Liability," EU Internal Markets Commissioner Charlie McCreevy said of auditor liability: “It is a potentially huge problem for our capital markets. The current conditions are not only preventing the entry of new players in the international audit market but are also threatening existing firms.”

Key points in the European Commission's (EC's) recommendation include:

The civil liability of statutory auditors and of audit firms arising from a breach of their professional duties should be limited except in cases of intentional breach of duties by the statutory auditor or the audit firm.

The limitation of liability should apply against the company audited and any third party entitled under national law to bring a claim for compensation.

Any limitation of civil liability should not prevent injured parties from being fairly compensated.

The EC explains in this Frequently Asked Questions (FAQ) document: “It is in the public interest to ensure sustainable audit capacities and a competitive market for audit firms at international level… liability risks arising from the increasing litigation trend combined with insufficient insurance cover may deter auditors from providing audit services for listed companies. If these structural obstacles (liability risks/lack of insurance) persist, mid-tier audit firms are unlikely to become a major alternative to the ‘Big 4’ audit networks on European capital markets… there is also a risk of losing some of the existing players. One of the reasons might be that catastrophic claims cause the collapse of one of the major audit networks.”

After noting that the EC adopted a recommendation on May 8 ‘strengthening the robustness and independence of inspections of firms auditing listed companies,’ the FAQ states: “Audit quality should be driven more by sound regular inspections whilst liability should complement such efforts but not make the audit business unattractive.” Furthermore, “audit regulators - not judges or courts - will in future play a pivotal role in maintaining the high audit quality which companies and investors deserve.”

The FT’s Hughes also quoted PwC partner Peter Wyman, saying, “This is a very significant step for auditors not just in Europe, but across the world because Europe will provide a lead.” Additional details on the EC recommendation are in this FEI summary (summary downloadable by FEI members only, see info on FEI membership).

U.S. Treasury ACAP Debates Liability; To Publish Addendum in FR for Comment
In related news, the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP) voted on June 3 to formally publish in the Federal Register - and seek public comment on - an Addendum to its May 5 Draft Report. There will be a 30 day comment period on the Addendum (presumably, 30 days after it is published in the Federal Register (FR), as of June 9, the Addendum had not yet been published in the FR.) As previously reported, the comment deadline on the May 5 Draft Report is June 13.

The Addendum includes one recommendation and three matters for further consideration: (1) a recommendation that the PCAOB reconsider the form and content of the auditor’s report, (2) whether engagement partners (not just the ‘firm’) should sign audit reports, (3) whether audit firms should be required to make public a set of audited financial statements for their own firm, and (4) whether it would be appropriate to transfer to federal court jurisdiction certain claims against auditors and related issues regarding a uniform standard of care.

ACAP discussed auditor liability more broadly at its June 3 and prior meetings, but has yet to reach a consensus on any recommendation pertaining to auditor liability, including the federal vs. state court jurisdiction matter noted in its Addendum.

Here are a few highlights from ACAP’s June 3 meeting, particularly on the liability issue:

Ernst & Young General Counsel Kathryn A. Oberly, testified that changes in the law - including the ‘water[ing] down’ and eventual abandon[ment] of the privity requirement’ - combined with the explosion in market cap of public companies, has largely resulted in the threat of catastrophic loss to audit firms sued in connection with their role in auditing public companies.

PwC General Counsel Charles W. Gerdts III (testimony) and attorney Michael R. Young of Willkie, Farr & Gallagher (testimony), explained that the threat of catastrophic loss limited audit firms’ abilities to exercise their right to take the matter to trial, instead having no real choice but to settle, rather than – as Oberly soberly put it – ‘bet the firm.’

AON Deputy Chairman Barry Matthews warned ACAP in his testimony: “I want you to know that at no time have we encountered a situation in which there existed as substantial a threat to the continued viability and sustainability of the audit firms as that created today by the potential for mega professional liability claims brought in US courts.”

ACAP member Professor Gary John Previts, President of the American Accounting Association, said: “Right now we have a federally sanctioned cartel, that’s a personal observation, but how else in the world can you get 12,000 public companies audited within 90 days of year-end?” He asked, “What high standard, what impossible standard, do you hold them to, to accomplish that feat,” and likened the current model to “the difficulty of trying to make the Western Union model work in the 21st century.”

Previts referenced earlier remarks of ACAP member and former SEC Division of Corporation Finance Director Alan Beller, who said: “One of the things this committee is charged with doing is to look over hills and corners; I’d like to look over a five-year corner, five-years from now I think it is a certainty the U.S. capital markets will be less than 30% of global market cap, [it’s in the] low 30s today; [the] second point [is], it is quite likely that one or more of the Big 4 [audit firms] will have established real global operating entities that function as single entities with single systems of corporate governance.” Beller continued: “It is 100% certain to me that if we do not find a better path, a different path, from the one we currently are on, the chances are precisely zero that the American firms will be part of those global networks.”

On the subject of audit firm transparency as it may relate to potential efforts for liability reform, ACAP co-chair Don Nicolaisen said: “Not withstanding commentary I’ve heard from firms, and others, I do think there is tremendous value to having audited financial information for the largest firms, I say that for a number of reasons, one is, if they are desirous of some sort of litigation reform, for us to go to Congress and make a recommendation and say we don’t have any financial information but we want you to consider [liability reform], doesn’t have any appeal. Simply giving you my expressed view on this, similar to Arthur’s view, [ACAP co-chair Arthur Levitt, Jr.] we feel strongly [audit] firms that occupy this space, importance to our capital markets, responsible for auditing 95% plus of market cap, to operate without a baseline of financial information is not acceptable, that doesn’t mean it may not be acceptable to the committee, I want to make sure you understand where I am coming from, Arthur is in the same place.”

More generally, Nicolaisen said, “those who have recommendations how to move forward with a solution that provides either transparency [e.g., providing audited or certain other information about the firms to the public] combined with liability matters or ends up with a position saying both [transparency and liability were] discussed and no resolution, at some point we’re not going to fruitfully continue dialogue, either there is a solution reasonably obvious or not.”

Additional details from ACAP’s June 3 meeting (human capital, including education, training, and general recruitment and retention was also discussed) can be found in this FEI summary (summary downloadable by FEI members only, see info on FEI membership).

Noting that ACAP’s next public meeting is July 22, Nicolaisen said, “we encourage comments from the public on anything we’ve done between now and the end of June, even if it trickles in the first few days in July [it’s] OK too.”

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Thursday, June 5, 2008

SEC IFRS Roadmap:New Commissioners Will Be on the Journey, Says White; Corp Fin Review Guidance Coming; FEI Forms CRIFR

SEC Corp Fin Director John White told FEI’s IFRS conference earlier today (June 5) that the SEC is working on the IFRS roadmap –‘it is not one of those back burner projects – it’s happening” Noting that confirmation hearings for three new Commissioners took place earlier this week, he emphasized “there will be five people voting – we have to get everybody in place” before proceeding on this major initiative. [UPDATE June 6: White's speech has been posted here: ]
“We are taking this journey with the new roadmap with three new commissioners,” White said, adding, “we on staff will have to begin to understand their views.”
In a meeting with the press following his formal remarks, White explained the roadmap will not be proposed rulemaking per se, although proposed rulemaking may be one of the signposts along the roadmap. Asked during the press session if the SEC will have a 'quiet period' in rulemaking, given in part the White House memo directing federal agencies planning to issue proposed (final) rules by June 1 (with a later date for final rules), White said "We anticipate continuing going on with business as usual," noting there are a number of proposed rules currently out for public comment relating to foreign issuers, as well as a concept release on oil and gas, and the recent XBRL rule proposal, on which he said, "I have every expectation XBRL rule will be adopted before the end of the year."
White outlined a number of key questions being considered within the halls of the SEC – including whether IFRS should be permitted or required, whether all public companies should be under the scope of the IFRS option or mandate, or a subset of companies, and timing and transition issues.

Some time ago, noted White, some may have entertained the ‘dream’ that U.S. GAAP would become the global standard. However, with more than 100 countries requiring or permitting IFRS, he said some may see it as ‘an inconvenient truth,’ but those people ‘need to wake up from that dream’ of the single global standard being U.S. GAAP, and recognize the global movement is to IFRS. He reiterated the aim has been to achieve a single set of high quality standards that are globally accepted.

He noted the SEC has been actively involved, including with international counterparts at IOSCO, and through agreements like the SEC-CESR workplan, in sharing the results of reviews of IFRS filings, and in discussing issues like enhancing the governance of the IASB.

Separately, White noted that the SEC will be posting, possibly as early as today, a paper describing how to deal with the Corp Fin review process, including issues such as how to proceed from Corp Fin review to take up matters with the Office of the Chief Accountant, if applicable. He emphasized that the objectives of the review process as applied to IFRS filings are consistent with that of the review of U.S. GAAP filings. UPDATE: Here is a link to the doc referenced by White, posted today (June 5): "Division of Corporation Finance - June 2008: Filing Review Process."

FEI President and CEO Michael P. Cangemi, introducing White, noted that FEI has focused on keeping its members educated on IFRS and other financial reporting matters, as well as the other needs of companies, including operational issues.

Some of these initiatives at FEI include the creation of an IFRS focused subcommittee within FEI’s Committee on Corporate Reporting (CCR), and the announcement today that FEI has led the formation of a new national coalition, the Corporate Roundtable on International Financial Reporting (CRIFR), to provide a forum for companies of all sizes and funding models to discuss all business issues related to the promulgation, implementation and convergence of IFRS by U.S. companies. CRIFR’s charter members include FEI, Eli Lilly, Honeywell, McGraw Hill, Source Technologies, SMSC and Tyco. See the FEI press release.

Today's conference, "The World Is Moving to IFRS - Are You?" was hosted by Financial Executives International (FEI), and exclusively sponsored by BNA Tax & Accounting.We’ll have more highlights from panels that followed John White's keynote in subsequent posts.

Wednesday, June 4, 2008

COSO Releases ED on Monitoring Internal Control; Can Impact Sarbanes-Oxley Section 404, SAS 112 Assessments of Internal Control

On June 4, 2008, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) released for public comment its Exposure Draft (ED) entitled, "Guidance on Monitoring Internal Control Systems." The comment period ends August 15, and final guidance is anticipated by Fall, 2008.

COSO's 1992 Internal Control -Integrated Framework (as supplemented by COSO's 2006 Guidance for Smaller Public Companies - which can be applied by companies of all sizes) is recognized by the SEC’s rule on management reporting, and in PCAOB’s internal control audit standard (AS5) as a suitable and generally accepted framework on which to base assertions as to the effectiveness of internal control under Sarbanes-0xley Section 404. For all intents and purposes in the U.S., the COSO framework is ‘the’ internal control framework. (The SEC and PCAOB permit reference to certain other frameworks used outside the US, such as Turnbull in the U.K.)

Similarly, private companies are subject to AICPA standards like SAS 112 on ‘Communicating Internal Control Related Matters Identified in an Audit’ which reference the COSO framework.

The proposed guidance contained in COSO’s Exposure Draft released June 4 more fully develops the Monitoring component of COSO's internal control framework. (The five components of COSO's internal control framework are: control environment, risk assessment, control activities, information & communication, and monitoring.)

The objective of the Monitoring ED is to assist companies in improving Monitoring to make it more efficient and effective, including to better leverage management's work in terms of reliance by auditors on that work, as part of the overall efficiency and effectiveness of internal control assessments.

Links to the 3 volume Exposure Draft (Exec Summary, Guidance, and Application Guidance or Examples) as well as an introductory letter from the COSO Chairman, Dr. Larry E. Rittenberg, and a related press release issued June 4, can be found on COSO's newly redesigned website here. Be sure to check out other aspects of COSO's redesigned website at
COSO selects a firm to lead a project team in developing its guidance. The project team includes representatives from COSO’s five sponsoring organizations (the AAA, AICPA, FEI, IIA, and IMA) and other experts. Grant Thornton, LLP was selected last year to lead the development of the Monitoring guidance under the auspices of the COSO project team. The project leader is R. Trent Gazzaway, Managing Partner of Corporate Governance, Grant Thornton LLP.

FEI President and CEO Michael P. Cangemi is FEI’s COSO board representative. Rick Brounstein, CFO of NewCardio, Inc. is FEI's member representative on the COSO Monitoring project task force, with input from members of FEI’s Task Force on Monitoring (TFM).
In fall 2007, COSO released a Discussion Document on Monitoring, a precursor to the current ED. Comments sent on the Discussion Document by FEI and others are posted here.

Check back to FEI’s website later this week for a summary of the COSO ED.