Tuesday, May 31, 2011

Beswick's 'Condorsement' and Herz' 'Improve and Adopt'

'Condorsement,' a term coined by SEC Deputy Chief Accountant Paul Beswick in his speech at the Dec. 2010 AICPA Conference, referencing an approach somewhere "in between" ... "convergence or... endorsement" of International Financial Reporting Standards, forms the basis of the proposal floated for public comment in the SEC Staff Paper on IFRS released on Friday.

Interestingly, the term 'condorsement' was used only once in that paper, and personally (now would be a good time to remind you of the disclaimer posted on the right side of this blog) I believe the term 'condorsement' was used sparingly because the SEC staff wanted to emphasize the sovereignty factor, and attention-to-high-quality factor, presumably subsumed under the proposed approach of Endorsement (ongoing Endorsement of IFRS by the FASB for use in the U.S.) prior to Incorporation of IFRS into U.S. GAAP, the central message of the staff paper. Thus, the emphasis was on thoughtful, paced Endorsement, potentially subduing some of the criticism (such as that of Albrecht & Selling) pointed at the Convergence half of the Con-dorsement equation, particularly as relate to a 'big-bang' type of wholesale movement to IFRS - something the SEC will continue to obtain feedback on, at its upcoming (July 7) roundtable on IFRS.

On the subject of Condorsement, one thing I find fascinating is the extent to which former FASB Chairman Bob Herz' 'Improve and Adopt' approach - first introduced in his testimony at a Senate Banking Committee, Securities Subcommittee hearing on Oct. 24, 2007 - can be viewed as a possible precursor to Beswick's "Condorsement."

Here's what Herz told Sen. Reed's subcommittee in 2007 about 'Improve and Adopt:"

We expect that the myriad changes to the U.S. financial reporting infrastructure would take a number of years to complete. During that time, the FASB and IASB should continue our cooperative efforts to develop common, high-quality standards in key areas where neither existing U.S. GAAP nor IFRS provides relevant information for investors. Those common standards, issued by both the FASB and IASB, would be adopted by companies in the U.S. and internationally when issued. In other areas that are not the subject of those joint improvement projects, we envision that U.S. public companies would adopt the IFRS standards “as is” over a period of years. The adoption of those IFRS standards by U.S. companies would complete the migration to an improved version of IFRS.

We believe there are many advantages to employing such an “improve and adopt” approach in transitioning to IFRS. Financial statement users both domestically and internationally will benefit from the continued, cooperative efforts by the FASB and IASB to improve, simplify, and converge financial reporting in those areas of existing U.S. GAAP and IFRS that are clearly deficient. Under this approach, new standards or existing IFRS will be gradually adopted over a period of several years, smoothing the transition process and avoiding the capacity constraints that might develop in an abrupt mandated switch to IFRS. Moreover, this approach permits the Boards to focus their resources on improving standards in areas important to investors, rather than on eliminating narrow differences among our many existing standards.

Compare that with Beswick's description of Condorsement in his Dec. 2010 speech:

...[W]hat would be a reasonable approach for the U.S.? In our October update we highlighted that the majority of jurisdictions are following either a convergence or an endorsement approach. In my opinion, if the U.S. were to move to IFRS, somewhere in between could be the right approach. I will call it a "condorsement" approach. Yes, I admit I just made up a word. And by the way, the patent is pending as we speak.

So how would this approach work? Well, to begin, U.S. GAAP would continue to exist. The IASB and the FASB would finish the major projects in their MOU. The FASB would not begin work on any major new projects in the normal course. Rather, a new set of priorities would be established where the FASB would work to converge existing U.S. GAAP to IFRS over a period of time for standards that are not on the IASB's agenda. This is not meant to be an MOU2 but rather would entail making sure that, on a standard by standard basis, existing IFRS standards are suitable for our capital markets.

At the same time, the FASB would have a process where they would consider new standards issued by the IASB for incorporation into U.S. GAAP and then integrate such standards into the U.S. codification. The ideal would be to incorporate such standards as issued by the IASB without modification. However, criteria would need to be established for FASB's consideration of endorsing or incorporating standards — for example whether incorporating a given standard is in the interests of U.S. investors or the U.S. capital markets. Sir David Tweedie has indicated in speeches that the IASB has already started thinking about their agenda after the completion of the MOU. I would expect the FASB to participate in the IFRS standard setting process much like other jurisdictions do. At the same time, I would expect that the IASB would take seriously the input of the U.S. in their deliberations.

So why consider this approach? I believe this approach is worthy of consideration and may work in the U.S. for various reasons, including the depth of the U.S. markets; the quality of our existing standards;, and, quite frankly, the existing consistency at the objectives level between many areas in U.S. GAAP and IFRS.
It is clear to me that this is in fact a method of incorporating a single set of standards into the U.S. market. But it also acknowledges our responsibility to the U.S. capital
markets and provides mechanisms to ensure that the standards must be high quality prior to their incorporation. If new standards of sufficiently high quality were incorporated into U.S. GAAP, the process of creating new differences would stop. Further differences would be eliminated one by one as new high quality global solutions are achieved.

It is important to note that the calculus of moving using a "big bang" date from existing standards to an alternative set of accounting standards presents a different set of costs and benefits, and different challenges for the U.S. as compared to other jurisdictions.
While our evaluation of the differences between U.S. GAAP and IFRS is ongoing, it seems clear that, in a number of major areas, the two sets of standards are consistent at the objectives level. Take, for example, PP&E, Share-Based Payments, or even Income Taxes. While I'm not at all suggesting that there are not differences, when the two bodies of standards are compared, the differences appear in many cases to be in the method of application as opposed to the objective of the standards. Requiring retroactive adoption, or even requiring new systems to be put in place prospectively on a big bang adoption date is something that requires serious consideration as to
whether they're necessary. This is particularly true where the IASB may be
considering modifications to their existing standards to avoid the imposition of
a "two-step" change.

Further, in the U.S. we have such a wide spectrum of companies that are currently using U.S. GAAP. The cost-benefit consideration is very different for many of these companies. For example, a large Fortune 50 company has different economic considerations (both as to costs and potential benefits) as compared to a small public company in Iowa. We need to be act very deliberatively and understand fully the benefits before we create the potential for such a significant burden on U.S. companies; particularly smaller public companies and private companies.

This approach may be appealing to some as it seems to provide for a way forward in achieving the broader objective, maintains our vital interest in the U.S. capital markets, and appears to do so in a way that would manage the burden of achieving the objective to an acceptable level. If the change is gradual, and if the smaller companies can learn from the larger companies, then the cost of incorporating a global set of standards should be decreased.

However, there are a number of questions that would need to be answered under such an approach. One of the most significant questions that needs to be considered is "Should the largest companies be required or allowed to move to IFRS prior to the FASB completing its condorsement efforts?"

In any case let me reiterate that all I have done is I've outlined an idea. Don't shoot me as it is just that, an idea. But I hope it demonstrates that we are serious in considering how to achieve the broad objective, to do so in a way that maintains the protections to U.S. investors we have been afforded though our standard setting processes to date, and to do so in a way that minimizes the cost ultimately born by the U.S. investing public.

So why shouldn't we just commit right now and move? As we noted in the progress report there are still some significant areas we are considering, including the quality of the standards, and the governance and funding of the IASB. In the meantime there are some potential pitfalls that remain before the Commission makes its

First and foremost, the efforts of the IASB and the FASB on the MOU projects need to result in high-quality accounting standards. If the efforts focus on meeting deadlines as opposed to producing high-quality accounting standards, it would be very difficult to see how we will end up with unified standards. I hope the Boards take the time they need to get the standards right and, if that means taking time past June 2011, I would be very supportive. Recently I was talking with an IASB Board member on the timing for completion of the MOU projects. The Board member noted that when they explain to their grandkids what they did while serving on the IASB, they hoped they could say they issued high-quality accounting standards rather than saying they issued an accounting standard by a specific date.

Another potential pitfall involves some of the sales literature and advertising I have recently observed by the larger firms that market their ability to help with the IFRS transition. I have seen advertising that creates the impression that the process will be challenging and painful. The implication is a company will not be able to convert to IFRS without outside help. I will note this type of tactic, as some have referred to them as "scare tactics", not only has the potential to put the profession in a bad light, they also reinforce some myths on the conversion to IFRS and could potentially hinder our ability to incorporate IFRS. Let me point out that the Commission has not yet made a decision on whether to incorporate nor have there been any decisions on the best method to do so. In the staff's efforts to complete the Work Plan, we intend to consider ways to lessen the burden on converting to IFRS while at the same time protecting the interests of investors.

As further detailed in last week's SEC Staff Paper, on which comments are due by July 31:

The FASB would continue to promulgate U.S. GAAP primarily through its endorsement of standards promulgated by the IASB. Under the framework, due to
the FASB’s participation in the IASB’s standard setting process, the FASB should be in a position to readily endorse (i.e., incorporate directly into U.S. GAAP) the vast majority of the IASB’s modifications to IFRS. However, the FASB would retain the authority to modify or add to the requirements of the IFRSs incorporated into U.S. GAAP, similar to other jurisdictions, and such U.S.-specific modifications would be subject to an established incorporation protocol. Such a protocol could entail the FASB determining whether the IASB’s modification to IFRS (either by means of issuance of a new standard or amendment of an existing standard) met a pre-established threshold—for example, a threshold that incorporates the consideration of the public interest and the protection of investors. If the IASB’s modification reaches that threshold, the FASB would incorporate fully the IASB’s adopted standard into U.S. GAAP. If the FASB concludes to the contrary, in incorporating the standard, it would need to determine whether it should modify the requirements of the standard, retain relevant U.S. GAAP, or find an alternative solution. Before making any modifications, the FASB could discuss the situation with other national standard setters to understand their perspectives on the issue and the approaches they have taken for endorsement of that standard in their respective jurisdictions.

In addition to incorporating new IFRS amendments into U.S. GAAP, the FASB also would exercise its authority as the national standard setter when it found, based on its experience in the ongoing interpretation or application of IFRSs incorporated into U.S. GAAP, that supplemental or interpretive guidance was needed for the benefit of U.S. constituents.

Although Herz' "improve and adopt" model circa 2007 is not precisely the same as Beswick's 2010-2011 "condorsement" model (which lies at the heart of last week's SEC Staff Paper), I believe at the very least that Herz, through his 'improve and adopt' model, can be viewed as the uncle, if not the father of condorsement.

Friday, May 27, 2011

Preparers Concerned About Change In Direction In FASB, IASB Leasing Proposal

Given the pervasiveness of leasing as a business practice and the potential impact of changes in lease accounting rules, FEI’s Committee on Corporate Reporting (CCR) has been following this project with great interest. Last week, several members tuned in to the webcast of the FASB-IASB joint board meeting and shared their views with me on the latest developments. In the view of those members, the changes voted on by the boards erased the substantial progress that had been made in redeliberations and made the standard more difficult and expensive to implement. [NOTE: Let me remind you of the disclaimer posted in the right margin of this blog; the disclaimer applies to my comments as well as those of the FEI members noted herein.] In brief, according to these members, the Boards decided to:

  1. Require front-end loaded expense recognition for all leases

  2. Eliminate special accommodations for short-term leases

  3. Reinstitute a complex approach to determining lease term
Refer to FASB’s official Summary of Board Decisions for full results of the meeting.

The decisions reached at last week’s FASB-IASB board meeting on leasing are in direct conflict with what CCR recommended in its comment letter on the Leasing Exposure Draft.

Additional insight on decisions reached in the discussion of the leasing project at last week’s joint board meeting can be viewed on the archived webcast of the meeting, which will be posted here.

According to one CCR member, “What is so disappointing about these developments is that they have occurred after unprecedented outreach and consultation, which served to clarify what investors say they want from a new leasing standard. The Boards appeared to listen and had made changes that were directly responsive to what they heard. Now, with time running out, much of this progress has been undone.” Details follow.

Pattern of Expense Recognition
According to the CCR members following the leasing project, last Tuesday the FASB voted 6-1 to keep it simple and force the expense recognition pattern for leases to equal the rental cost recorded under lease accounting today while a majority of the IASB wanted to revert to the much-criticized ED principle that front-end loads expense.

By Thursday, the IASB view had prevailed. The IASB was not in favor of an approach to depreciation of the asset that was other than straight line (e.g., some had suggested a sinking-fund approach that would effectively offset the accretion of the liability using the interest method). The consequence of the IASB’s decision, in the view of these CCR members, is that the expense of the lease is overstated in the early years and understated in the later years. During outreach, as observed by the CCR members, investors were emphatic that this approach was not helpful to them. John Smith, an IASB member from the US (formerly a partner with Deloitte and Touche), had noted that investors will simply have to make adjustments to the reported amounts if they don’t like front-end loading. This raises the question of whether the changes arising from this project will make the accounting more useful or understandable for users.

According to the CCR members, this decision raises complications in a number of important areas, including making it very difficult to deal with large numbers of small dollar leases through materiality. They point out that companies are going to need to compute the expense under both old GAAP and new GAAP in order to make the case that it is immaterial. Having to go through the trouble of doing so could compel many companies, say the CCR member, to decide to make the systems changes to actually book them that way, which could mean incurring hundreds of millions of dollars in IT costs – all to produce financial results that analysts are going to adjust back to eliminate the front-end loading.

Eliminate the accommodation for short term leases

For those leases with a maximum term of 12 months or less, the ED proposed that they be recorded on balance sheet, but granted preparers “relief” by not requiring them to discount recorded amounts.

In redeliberations, the Boards had tentatively decided to ease the burden further by allowing short term leases to be accounted for just like operating leases are today.

However, last week the Boards signaled that they plan to eliminate any relief for short term leases.

Defining the lease term
The ED would have lessees recognize lease assets and liabilities on the basis of the longest possible lease term that was “more likely than not” to occur. During outreach, note the CCR members, this approach was widely criticized by preparers and users.

During redeliberations, the Boards voted to further simplify by moving the definition of lease term to the definition used today. Last Thursday, the Boards decided to reverse course and factor lessee intent into the decision. As a result, lessees and lessors will need to consider contract, asset and other entity specific factors when determining the lease term at inception and each time that term is reassessed. The CCR members observe that this will be very challenging for preparers at do for each individual lease.

CCR members tuning into the most recent deliberations on the leasing project also raised questions about the process. After significant efforts to gather constituent feedback, the Boards, in the view of CCR members following the leasing project, appear to be backing away from acting on what they heard. In particular, these members believe, the desire to finish the leasing project seems to be more important than improving the principles of the final standard.

Warren McGregor, an IASB Board member (and a career standard setter), made it clear that anything other than the ED’s approach on expense recognition would require re-exposure of the proposal and delay issuing the final standard. Accordingly, CCR members following this project believe, the more likely path the Boards will follow will be to post the revised conclusions to the Leasing proposal in the form of a Staff Draft on their websites for informal review.

The CCR members note that the posting of a Staff Draft is not the same level of due process as posting a formal Exposure Draft for public comment. The process, they explain, would be much like so-called “fatal flaw” drafts, in which a principle will only be reconsidered if there is something obviously (and fatally) wrong with it. Therefore, they note, if a company responds to the ‘staff draft’ by reiterating the concerns they expressed in their response (comment letter) to the earlier Exposure Draft, the response they will likely get is the following: the Boards carefully considered these arguments in their due process deliberations, and the company has not identified any new information that would cause the Boards to change their minds.

As previously reported, FEI President and CEO Marie Hollein had written to both Boards last month, applauding the boards decision to take the time necessary on the remaining major convergence projects, and asking that the boards formally publicize and seek comment on the revised conclusions under these projects by formally re-exposing them for public comment, each with at least a 90-day comment period. (See FEI April 19, 2011 comment letter to FASB, IASB.) The above discussion on leasing, note the CCR members following this project, underscores the importance of the recommendation made in Hollein's letter.

SEC Releases Staff Paper on FASB Endorsement Of IFRS, Incorporating IFRS Into U.S. GAAP

Yesterday, the SEC quietly posted a "Staff Paper" on the "Incorporation" of IFRS into the financial reporting system for U.S. issuers. As noted in the Request for Comment at the conclusion of the IFRS Staff Paper (emphasis added):

The Commission has yet to make a decision as to whether and, if so, how, to incorporate IFRS into the financial reporting system for U.S. issuers. This Staff Paper describes how one possible incorporation approach could be used to incorporate IFRS into the financial reporting system for U.S. issuers, if the Commission were to choose to do so. However, the Staff acknowledges that this is not the only possible approach of incorporation. Other possible methods of incorporation have been explored previously in much greater detail (e.g., providing for optional use or specifying mandatory, date-certain incorporation). Given the extensive discussion on these other alternatives and given the consideration by the Commission as to whether or when IFRS may be incorporated into the U.S. financial reporting system, the Staff is interested in constituents’ views on the framework and any other possible approaches of incorporation of IFRS, including views on those approaches explored previously. Feedback can be provided through the SEC website by following the link below. Feedback would be most helpful if received before July 31, 2011.

Here is the new 'approach' to possible 'incorporation' of IFRS into the financial reporting system for U.S. public co's, described in the SEC's IFRS Staff Paper (emphasis added):

The Staff’s discussion in this Staff Paper is not intended to suggest that the Commission has determined to incorporate IFRS or that the discussed framework is the preferred approach or would be the only possible approach. The framework is presented to illustrate that:

1. The decision faced by the Commission in an effort to achieve a single set of high-quality, globally accepted accounting standards is not necessarily a binary decision (i.e., either to require the use of IFRS by all U.S. issuers immediately or not);

2. Incorporation of IFRS is not inconsistent with the SEC maintaining its ultimate authority over U.S. accounting standard setting; and

3. There are potential ways to accomplish the broad objective of pursuing a single set of high-quality, globally accepted accounting standards while minimizing cost, effort, and other transition obstacles.

The framework explored in this Staff Paper is predicated on several principles.

First, U.S. GAAP would be retained, but the Financial Accounting Standards Board (“FASB”) would incorporate IFRS into U.S. GAAP over a defined period of time, with a focus on minimizing transition costs, particularly for smaller issuers. The FASB would incorporate newly issued or amended IFRSs into U.S. GAAP pursuant to an established endorsement protocol. This would require a change to how the FASB currently operates. Similar to other jurisdictions, the endorsement protocol would provide the Commission and the FASB the ability to modify or supplement IFRS when in the public interest and necessary for the protection of investors. Such framework would share many key features of other major jurisdictions’ processes for incorporating IFRSs into their respective national financial reporting frameworks. However, whereas many countries chose to align existing accounting standards with IFRS through a “first-time adoption” of IFRS and thereafter keep pace with new or amended IFRSs through endorsement procedures, the framework explored in this Staff Paper would include a transitional period during which existing differences between IFRS and U.S. GAAP would be eliminated through ongoing FASB standard-setting efforts.

While certain operational aspects of the framework are discussed in this Staff Paper, the framework represents only one possible approach to incorporation of IFRS. The details of this framework, and other potential methods of incorporation, would need to be subject to further review and development, if and when the Commission determines that IFRS should be incorporated into the financial reporting system for U.S. issuers. Lastly, in various forums, the notion of an early-adoption option for U.S. issuers to use IFRS has been discussed. While the consideration of an option is beyond the scope of this Staff Paper, the Staff is continuing to consider the possible mechanics and implications of an option for U.S. issuers and how it would work in the context of the framework or otherwise.

As previously reported, the SEC is holding a public roundtable (on the incorporation of IFRS into the U.S. public company financial reporting system) on July 7.

My Three Cents
[I remind you of the disclaimer posted on the right side of this blog.] This opinion section is usually labelled 'my two cents' but the question of moving to IFRS is such a big issue it requires an expansion to three cents.

In general, the issue of whether and when to permit or require U.S. public companies to report to the SEC (and, in order to not have to maintain 2 sets of books, to other regulatory bodies, including the IRS) using International Financial Reporting Standards published by the International Accounting Standards Board, instead of U.S. Generally Accepted Accounting Principles published by the U.S. Financial Accounting Standards Board, has been a divisive issue, with emotions running high on both sides of the issue, not to mention both sides of the Atlantic and Pacific. But, is there as much of a gulf, or are the parties really an ocean apart?

The key flashpoints between the two sides, in my view, involve three issues. Here is a synopsis and my view on how the SEC's IFRS Staff Paper addresses these points:

  1. the question of whether it should be a mandatory requirement for public companies to move to IFRS, and if so, timing thereof ('date certain' being far enough out to allow sufficient transition time), vs. optional permission to report under IFRS instead of US GAAP. The SEC's IFRS Staff Paper clearly states that a move to IFRS is not necessary a 'binary' (aka all-in, all at once) decision, and emphasizes that indeed, the SEC has not yet reached any final decision. In fact, I would applaud the SEC for having the courage to take the time to explore new avenues (such as standard-by-standard 'endorsement' of IFRS by the U.S. FASB for incorporation into the U.S financial reporting system, the approach highlighted in the IFRS Staff Paper), rather than trying to close in on a final decision this early in 2011, or even by year-end 2011, if they determine that further time is necessary to reach a decision on this issue which could change the face of financial reporting, having incredibly significant consequences for investors, preparers, auditors, regulators, and others.

  2. as a subpoint to the question of whether there should be a mandatory move to IFRS in the US, some folks that are more in the 'when' camp (vs. the 'if' camp) would like sufficient time to be afforded to thoughfully minimize remaining differences between US GAAP and IFRS while still maintaining high quality standards, and to allow sufficient time for all parties (preparers, auditors, academics, lenders, investors, regulators, board of directors members, and others) to sufficiently transition before the 'live' move to IFRS takes place. This would be to avoid a 'perfect storm' or unintended consequences or misunderstandings of the information provided in the financial statements under IFRS vs. US GAAP, including as relate to legal covenants that currently reference US GAAP-based threshholds (i.e. dollar amounts measured in US GAAP-based reports) or minimums/maximums. Once again the SEC is to be applauded for circulating a new concept for incorporation that is more of a compromise concept, and more akin to what other jurisdictions are doing in terms of 'endorsement' of new IFRS standards, as outlined in the SEC's Staff Paper. The SEC staff have clearly been doing their homework and they are to be commended for proactively seeking broad public comment on the new ideas they have developed based on their continuing outreach, rather than limiting themselves to ideas floated in the original IFRS roadmap proposal.

  3. the 'sovereignty' issue: whether the US as a nation would give up its role (assigned to the SEC by Congress through the Securities Acts, and traditionally delegated by the SEC to the U.S. FASB, with additional formal authority over this arrangement baked in through the Sarbanes-Oxley Act) in accounting standard-setting. The SEC's IFRS staff paper addresses this issue head-on by stating that US GAAP would be retained (albeit by transitioning to IFRS over time as the FASB vets new IFRS standards for incorporation into U.S. GAAP), and that a mechanism would be provided for the SEC and FASB to "modify or supplement IFRS when in the public interest." Whether the various vocal (and less vocal) parties agree that the FASB 'endorsement' followed by 'incorporation' approach sufficiently addresses their concerns about sovereignty remains to be seen, and the best place for all views to be placed on this and other issues is through the comment letter process and by following and participating actively in the SEC's (as well as FASB's, the PCAOB's, and IASB's) outreach activities.

Thursday, May 26, 2011

SEC Adopts Whistleblower Rule By 3-2 Vote, Encouraging - But Not Requiring - Internal Reporting First

The SEC's whistleblower rule (final rule, press release) adopted in a 3-2 vote by the Commission yesterday, has received criticism in some circles mainly because it encourages - but does not require - whistleblowers to report their assertions internally within their company first, before going to the SEC.

As noted in the NYSE-Euronext Inside the Beltway blog, the proposed rule which preceded the final rule "received 240 comments and over 1300 form letters." That blog also notes:

Commissioners Casey and Paredes, the two Republicans on the Commission, voted
against the final rules and argued that, despite this change, the regulations would diminish the effectiveness of internal compliance programs. Commissioner Casey predicted the SEC would be flooded with tips and that companies would face
significant cost increases for legal fees required to respond. Schapiro said,
however, that the final rules “expand upon the incentives for whistleblowers to
report internally where appropriate to do so.”

A major goal of the new whistleblower rule, as required under Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, is to authorize the SEC to pay a 'bounty' or reward to whistleblowers providing information on alleged securities law violations, who meet certain requirements.

Previously, only those whistleblowers alleging violations of insider trading laws were eligible for bounty payments; the lack of a broader whistleblower bounty program was emphasized in the course of the investigation of ponzi schemer Bernard Madoff, where whistleblower Harry Markopolous was not eligible for such a bounty (although that did not stop Markopolous from submitting detailed allegations to the SEC).

The change in the rule, as set forth in the Dodd-Frank Act, is to encourage more potential whistleblowers to come forward by providing them with a financial incentive.

However, one of the arguments against the SEC rule in its proposed, and now final, form, is that the rule fails to take advantage of internal compliance systems within companies, and in the view of some, could weaken those compliance systems, by not requiring whistleblowers to present their allegations through those existing compliance systems and going direct to the SEC. A counterargument put forth by others, however, is that a requirement to present a whistleblower complaint internally before going to the SEC is that the whistleblower may avoid making the complaint due to fear of retribution. The SEC tried to reach a compromise in the wording of the final rule to navigate this chasm involving the desire to, one the one hand, encourage but not require internal reporting, and on the other hand, discourage retribution:

  • the rules make it unlawful for anyone to interfere with a whistleblower’s efforts to communicate with the Commission, including threatening to enforce a confidentiality agreement

  • the rules... [p]rovide that a whistleblower’s voluntary participation in an entity’s internal compliance and reporting systems is a factor that can increase the amount of an award, and that a whistleblower’s interference with internal compliance and reporting is a factor that can decrease the amount of an award.

As reported earlier today by Broc Romanek in TheCorporateCounsel.net blog:

House Representative Michael Grimm (R-NY) has introduced a bill that seeks to change the whistleblower provision in Dodd-Frank. Some believe the bill was introduced to put pressure on the SEC ahead of its rulemaking. This May 24th letter from a group of groups asks Congress to leave the whistleblower provision

Romanek's blog post also provides links to some law firm memos issued yesterday on the SEC's final whistleblower rule.

Here are some links to additional articles and points of view:

SEC Adopts Its Revised Rules for Whistleblowers (NYT DealBook)

U.S. Chamber Warns New Whistleblower Rules Will Undermine Corporate Compliance Programs (US Chamber of Commerce press release)

Association of Corporate Counsel Frustrated by Today’s SEC Ruling on Whistleblowing Bounty Provisions of Dodd-Frank Law -- In-house Counsel Warn of Adverse Effect on Corporate Compliance and Internal Reporting

Reactions to SEC Whistleblower Rules Fall Predictably (WSJ Corruption Currents blog)

The Government Will Pay You Big Bucks to Find the Next Madoff (Forbes Working Capital blog)

Wednesday, May 18, 2011

Diversity In Focus In SEC Commissioner Aguilar's Remarks, FEI Initiatives

SEC Commissioner Luis Aguilar, in a series of recent speeches and statements, has been speaking out on the need for corporate boardrooms, regulators, and the SEC itself, to increase diversity among its ranks, including senior ranks. He also included a reminder about an SEC rule promulgated in 2009 requiring public companies to disclose more about their policies related to nominating a diverse board, and the companies' evaluation of the effectiveness of those policies.

In remarks before the 2011 Hispanic Association of Corporate Responsiblity-Corporate Directors Summit on April 30, Aguilar focused on:

the need for corporate America and its regulators to embrace this nation’s growing diversity. It is past time to see the diversity of our nation reflected in corporate boardrooms, in the financial industry, and in the government.

The State of Diversity Today
Among the points noted in Commissioner Aguilar's speech, supplemented by his May 2 statement - strongly titled "The Abysmal Lack of Diversity in Corporate Boardrooms is Growing Worse" - were:

  • Boardrooms: Citing statistics from a 2008 report published by the Alliance for Board Diversity, Aguilar stated, "There is a persistent lack of diversity in corporate boardrooms across this country — and women and minorities remain woefully underrepresented.' Citing from the ABD's May 2, 2011 report, he noted that diversity among women and minorities in corporate boardrooms decreased from 2004-2010.

  • Senior management: "Unfortunately, corporate boardrooms are not the only place where diversity is lacking. The lack of diversity in the securities industry is particularly acute. The most recent Government Accountability Office report on employment in the financial services industry found that the percentages of African Americans and Hispanics in senior-level management positions were just 2.8 % and 3%, respectively. Clearly, the industry must do substantially better."

  • The SEC: "I would be hiding the ball if I didn’t also point out the lack of diversity at the SEC. While 32 percent of the SEC work force comprised people of color in 2010, only 19% of our attorneys were people of color. The most telling numbers are of our senior officers. As of fiscal year 2010, the SEC’s senior officers were approximately 90% white, 3% African-American, 2% Hispanic and 2% Asian. The gender breakdown among these senior officers is 69% male and 31% female."... He added: "Moreover, I find it puzzling that the SEC, an agency known for championing full and fair disclosure, does not publicly release its EEOC data on its workplace diversity. All covered federal agencies, of which the SEC is one, are required to file an annual report with the Equal Employment Opportunity Commission, entitled the 'Federal Agency Annual EEO Program Status Report.' Many federal agencies, including ones with much larger workforces—most notably, the United States Army, the Department of Veterans Affairs, and the Department of the Interior—publically disclose these reports which include data regarding the gender, racial, and ethnic makeup of their respective workforces. I think it is past time that the SEC should do the same." He added, "It is absolutely clear that the SEC is not doing enough to recruit, retain, and advance minority candidates at the professional and senior leadership levels," and stated, "I am committed to improving the diversity of the SEC’s workforce and I am continuing to work closely with our Office of Human Resources to do just that."

  • Financial Regulators: "Section 342 of the Dodd-Frank Act requires that the SEC undertake significant efforts to recruit and promote employees from all backgrounds. In particular, Section 342 requires that the SEC, and all other financial regulators, establish a new Office of Minority and Women Inclusion. Many of our financial regulator counterparts, like the FDIC, the Federal Reserve, and the Department of Treasury have already established this program and have the new office, director and staff in place. I look forward to the SEC establishing its office and quickly catching up to our counterparts."

SEC Notes Weaknesses In Compliance With Disclosure Requirements

Regarding SEC disclosure requirements for identifying diverse board nominees, Aguilar noted that:

[I]n late 2009, the Commission adopted a rule to assess a company's commitment to developing and maintaining a diverse board. In summary, public companies are now required to disclose whether diversity is a factor in considering candidates for nomination to the board of directors, and how the company assesses how effective the policy has been.

...Just recently the SEC staff reviewed the disclosures made by several hundred companies resulting from the new diversity disclosure requirement. From this review, the staff issued a number of comment letters. The results of this review seem to indicate that there are two primary areas of compliance weakness.

First, some companies are failing to disclose important information regarding their board of director diversity policies. These companies are drawing a false distinction that disclosure is only required if the company has a “formal” policy, rather than an “informal policy.” These companies and their advisors need to go back and review the rule. The rule states companies must disclose “whether, and if so how, a nominating committee considers diversity in identifying nominees for director.” But it does not end there. It also states that if a company has a “policy with regard to the consideration of diversity in identifying director nominees,” the company must disclose “how this policy is implemented and how the nominating committee or the board assesses the effectiveness of its policy.” This disclosure does not depend on whether the policy is defined as “formal” or “informal.” Moreover, these companies seem to have forgotten why investors asked for this disclosure, and why the SEC promulgated this rule — it is because investors care about board diversity issues and it is an important factor when they make investment and voting decisions. Investors do not care if the diversity policy is formal or informal; they care about the substance of the policy and whether it is effective.

Second, for those companies who do disclose they have a policy, we are seeing incomplete disclosure regarding the evaluation of the effectiveness of the policy. Thus, companies are complying with the first prong of the rule but not the second—which requires the company to disclose how it evaluates the diversity policy’s effectiveness. It is important that all companies — not just those with good stories to tell — comply with both prongs of the rule. The rule requires companies to be transparent about how they treat diversity and full compliance with the rule is the only way to achieve this goal.

Commissioner Aguilar added:

I know these companies can do a better job. I have asked the SEC staff to continue to monitor this situation to make sure companies are transparent about their diversity policies.

Commissioner Aguilar identified a number of organizations that compile lists of highly qualified women and minority candidates for board positions. Refer to the text of his remarks and the footnotes thereto.

FEI Diversity and Inclusion Initiatives
In addition to the resources listed in Commissioner Aguilar's speech, another source of talent can be found at Financial Executives International, an association of over 15,000 senior financial executives. FEI has a long-standing Director's Registry and Resume Bank of FEI members seeking positions as directors or in senior management. These resources are available in FEI's Career Center.

Additionally, FEI launched a Diversity and Inclusion initiative, whose Mission Statement states:

Our mission is to increase diversity of FEI’s membership to reflect the diversity of our profession and builds a culture of inclusion. This culture is one that embraces and leverages the differences and similarities of each FEI member, with the goal of enhancing the networking, advocacy and leadership that defines FEI. As a global leader, a diverse perspective is essential to our continued success and one of our greatest values is having an inclusive environment that respects each individual and enables our members to reach their full potential.

Other points noted on FEI's Diversity & Inclusion webpage:

Why is increasing diversity so important for FEI?

  • Diversity is the face of the business world today and will be even more so in the future

  • Diversity is important to our members’ employers and they have been moving forward in implementing initiatives and strategies of their own

  • Increasing diversity is simply, good business

  • Increasing diversity of thought, experience, backgrounds, and points of view will lead to stronger [FEI] Chapters and expand the pool of potential Chapter leaders and committee members

Taylor Hawes, CFO Intellectual Property & Licensing at Microsoft, and Chairman of FEI's Diversity Committee, notes:

“ Diversity is important to FEI and to good business; especially when diverse populations account for over 44% of the global GDP and within the U.S. over $9 trillion dollars. Financial Executives International has a national diversity task force focused on increasing the diversity and inclusion of our membership. Activities ranging from combined networking - such as our programs held in conjunction with ALPFA (Association of Latino Professionals in Finance and Accounting), NABA (National Association of Black Accountants, Inc.) & ASCEND (Pan Asian Leaders in Finance and Accounting) - and professional development and networking events brings recognition and focus to the importance of creating an environment that celebrates our similarities as well as our differences."

Read more about these activities on FEI's Diversity Initiatives webpage. FEI members, prospective members and others interested in learning more about FEI's diversity and inclusion initiatives, contact Jackie Major, Senior Associate, Chapter Support at jmajor@financialexecutives.org.

Post-Implementation Review; New Standards, Too: Subject of FASB, IASB Webcasts

Webcasts are set to take place later this week and next week covering (1) FASB’s post-implementation review process, and (2) four recently issued IASB standards, respectively.

This Friday, the Financial Accounting Foundation, which oversees the Financial Accounting Standards Board and the Governmental Accounting Standards Board, is hosting a webcast explaining the next phase of its post-implementation review process. The May 20 webcast, set to take place at 1pm EST, will feature FAF President and CEO Terri Polley, FASB Chairman Leslie Seidman, and Post-Implementation Review Leader Mark Schroeder discussing the pilot test of the post-implementation review process, and an upcoming stakeholder survey. Learn more about the FAF/FASB webcast, and register here.

Next week, the IASB will be holding a webcast on May 23 on its new fair value measurement standard, IFRS 13 (as previously reported, IFRS 13 was issued by the IASB concurrent with FASB's release of ASU 2011-04 on fair value measurement). A separate webcast will be held on May 25 on IASB’s new standards on off-balance sheet arrangements and joint arrangements (IFRS 10, 11 and 12). The IASB has also published a series of Frequently Asked Questions, project summaries and feedback statements on the new standards. Read more about the IASB webcasts and summaries of the new standards.

Thursday, May 12, 2011

FASB, IASB Publish Converged Fair Value Measurement Standards

Earlier today, FASB and the IASB published converged standards on fair value measurement and disclosure, with FASB's issuance of Accounting Standards Update (ASU) 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, which updates the FASB Codification on fair value measurement (previously predominantly from FAS 157, Fair Value Measurement), and the IASB's issuance of IFRS 13, Fair Value Measurement.

Effective Date
As noted in the FASB in Focus providing highlights of the accounting standards update: "The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011. Early application by public entities is not permitted. Nonpublic entities may apply the amendments in this Update early, but no earlier than for interim periods beginning after December 15, 2011."

Following are some highlights from FASB ASU 2011-04, from the FASB in Focus:

"The concepts of highest and best use and valuation premise in a fair value measurement should be applied only when measuring the fair value of nonfinancial

"Similar to comparable guidance for liabilities, the fair value of an instrument classified within a reporting entity’s shareholders’ equity should be measured from the perspective of a market participant that holds that instrument as an asset.

"For fair value measurements categorized within Level 3 of the fair value hierarchy, a reporting entity is required to disclose quantitative information about the unobservable inputs used in the measurements.

"The amendments that change a particular principle or requirement for measuring fair value or disclosing information about fair value measurements include the following:
▪▪Provided that certain criteria are met, a reporting entity that holds a group of financial assets and financial liabilities that exposes it to market risks and counterparty credit risk may apply an exception to the requirements in Topic 820, which permits the fair value of those financial instruments to be measured on the basis of the reporting entity’s net risk exposure.
▪▪Premiums or discounts may be applied in a fair value measurement to the extent that they are consistent with the unit of account and market participants would consider them in a transaction for the asset or liability. However, adjustments commonly referred to as blockage factors are not permitted in fair value measurements.
▪▪A reporting entity must disclose the following information about fair value measurements:
--For fair value measurements categorized within Level 3 of the fair value hierarchy:
• The valuation processes used by the reporting entity.
• A narrative description
of the sensitivity of the fair value measurement to changes in unobservable
inputs and the interrelationships between those unobservable inputs, if any.

--The use of a nonfinancial asset if it differs from the highest and best use assumed in the fair value measurement.
--For items that are not measured at fair value in the statement of financial position but for which the fair value is required to be disclosed, the level of the fair value hierarchy in which that measurement is categorized. "

Nonpublic entities

As stated in the FASB in Focus: "The Board concluded that certain disclosure requirements in this Update should not be required for nonpublic reporting entities, such as the requirement to disclose any transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for those transfers."

Remaining Differences Between IFRS and U.S. GAAP In Converged Standard
Those looking for a detailed mapping between the provisions of IFRS 13 and FASB's Codification as updated by ASU 2011-04 can refer to the Table of Concordance posted by the boards.

Some of the remaining differences between the newly converged standards, as described in the FASB in Focus, include: "There are some different disclosure requirements about fair value measurements.

"The most significant difference is that IFRSs require a quantitative sensitivity analysis for financial instruments that are measured at fair value and categorized within Level 3 of the fair value hierarchy. U.S. GAAP does not require a quantitative sensitivity analysis disclosure.

"There are different requirements about whether, and in what circumstances, an entity with an investment in an investment company may use the reported net asset value as a measure of fair value."

Additional Information

FASB and IASB have published some very helpful information, accessible on their websites, to assist constituents in learning about the changes to the current FASB, IASB standards. These include: IASB-FASB joint press releasel; FASB podcast featuring FASB Director of Communications Neal McGarity and FASB Board Member Russ Golden; IASB podcast featuring IASB Director of Communications Mark Byatt, IASB Board Member Warren McGregor, and IASB Project Manager Hilary Eastman (NOTE: podcast is currently accessible from this webpage); FASB in Focus (May 12, 2011); IASB Project Summary and Feedback Statement (May, 2011)

IFRS 10, 11, 12 Issued On Off-Balance Sheet, Joint Arrangements
In other action, the IASB published three additional IFRS standards today: IFRS 10, 11 and 12 amending their current standards with respect to off-balance sheet and joint arrangements. As noted in the IASB's press release: "The completion of this review brings the accounting treatment for off balance sheet activities in International Financial Reporting Standards (IFRSs) and US generally accepted accounting principles (GAAP) broadly into alignment, and concludes an important element of the IASB’s comprehensive response to the financial crisis.

•IFRS 10 Consolidated Financial Statements builds on existing principles by identifying the concept of control as the determining factor in whether an entity should be included within the consolidated financial statements of the parent company. The standard provides additional guidance to assist in the determination of control where this is difficult to assess.

•IFRS 11 Joint Arrangements provides for a more realistic reflection of joint arrangements by focusing on the rights and obligations of the arrangement, rather than its legal form (as is currently the case). The standard addresses inconsistencies in the reporting of joint arrangements by requiring a single method to account for interests in jointly controlled entities.

•IFRS 12 Disclosure of Interests in Other Entities is a new and comprehensive standard on disclosure requirements for all forms of interests in other entities, including joint arrangements, associates, special purpose vehicles and other off balance sheet vehicles.

Keeping Up With Change!
How can you keep up with the latest FASB developments? Check out the FASB Update sessions taking place in May and June, cosponsored by Executive Enterprises Institute and FEI.

Friday, May 6, 2011

No Silver Bullet for Audit Profession, Says PCAOB's Doty

In remarks at Baruch College yesterday, PCAOB Chairman Jim Doty said there was “no silver bullet” to address the challenges facing auditors, the audit model, and by extension, audit regulation today. Doty’s remarks were made in a keynote address at the Zicklin Center for Corporate Integrity’s 10th annual Financial Reporting Conference. Other speakers included FASB Chairman Leslie Seidman, SEC Chief Accountant Jim Kroeker, and other representatives of regulatory agencies and the private sector, including FEI President and CEO Marie Hollein.

Doty named three forces at work impacting auditors vis-à-vis maintaining the public trust:

  1. the payment model: the auditor is hired and fired by the company itself. The Sarbanes-Oxley Act's reform to shift hiring and oversight of the auditor from management to the audit committee may in practice have proved insufficient to counteract that conflict and others facing the auditors. As with management, audit committees may see their job as negotiating the lowest audit fee, not championing auditor objectivity and independence from management. In this environment, not surprisingly, the scope of the audit has not grown, even if society's expectations have. As the guardian of a cultural value, the audit is arguably as important as electricity or water. But if it is to retain that lofty status, auditors and the PCAOB need to do our best to make sure the audit is useful.

  2. The statutory franchise… [which] protects the profession as a whole from the risks of obsolescence, thereby reducing auditors' need to adapt to investor needs. As a result, auditors don't have a natural incentive to evolve their reports to what investors want.

  3. Conflict of interest…[and] the incentives of others in the environment auditors operate in … deter the profession itself from innovating the audit to meet public expectations the way, say, a technology company would, or a properly incentivized service company would.

Too Big To Fail? Too Important To Leave Unregulated
Saying, “There is no silver bullet to address these challenges,” Doty added, “There are as many or more problems with structural alternatives such as a third-party payor or insurance-based system; and in a dispersed ownership society, eliminating the audit requirement would be impractical and outright reckless. Therefore, our initiatives should go to reducing risks that follow from these conflicts and challenging incentives that weaken investor protection by applying counter-weight."

Referencing a recent statement in a report published by the U.K.’s House of Lords, that “There is inevitably a connection between the assessment of the Big Four's performance and the question . . . of market concentration,” Doty countered: “I do not believe that the global audit firm networks themselves pose systemic risk to our economy. But initiatives to shrink the global firms would likely further weaken their ability to audit the large, multi-national companies that may themselves be systemically important.”

“The global audit firm is not too big to fail, it is too important to leave unregulated,” said Doty. He continued, “To protect investors, governments should regulate such firms, not cripple them.”
Concept Release Coming in “Early Summer” on The Auditor’s Report
Doty noted, “The PCAOB is engaged in a broad dialogue with investors, auditors, audit committees, preparers and others to consider how the auditor's report can be changed to provide more useful, relevant and timely information. The central questions emerging in our dialogue are: What should auditors' responsibilities to the investing public be? What can auditors be expected to do? And, how do we close the expectation gap in a meaningful way? "

He added, “We expect to issue a concept release in the early summer summarizing and analyzing the input we've received. That concept release may result in the first substantial changes to the reporting model in more than half a century. The release will explore various possibilities and seek specific feedback.”

Standard-setting initiatives
Among the standard-setting initiatives outlined by the PCAOB Chairman were:

  • improving audits of fair value measurements,

  • improving communications among affiliated firms in global networks engaged in multi-national audits

  • global quality controls, and

  • improving auditors' communications with audit committees.
“Our improvements in standards are not intended to be traps or trip-wires for auditors,” emphasized Doty. “We write standards so that expectations are clear.”

Also addressed in Doty’s remarks were matters relating to PCAOB oversight and inspections of US and multinational audit firms.

See More
If you are interested in the subject of audit regulation, check out a program being offered by the Stan Ross School of Accountancy at Baruch College on Monday May 9: Changes in the Regulatory Environment and their Effects on Audits and Auditors. Featured speaker at the program, which will take place from 5:30-6:30 pm, is Peggy Wood, Professional Standards Partner at Grant Thornton LLP and President of the New York State Society of Certified Public Accountants. Pre-registration is required; there is no fee to attend.

Read More
Further reading on the subject of audit regulation can be found in Francine McKenna’s Re:The Auditors Blog (McKenna is always interesting, always controversial) and Jim Petersen’s Re: Balance Blog (Petersen’s point of view is formidable, with his background as a former senior in-house lawyer and partner at one of the largest global audit firms.)

Thursday, May 5, 2011

Economic Optimism Dips Slightly in U.S., Europe: FEI-Baruch CFO Outlook Survey

The recently released survey results of the quarterly CFO Outlook Survey, conducted by FEI and Baruch College's Zicklin School of Business, show a dip in optimism for the 1Q 2011. In addition to surveying CFO confidence and optimism levels in the U.S. and Europe, the survey addresses CFO views on the potential impact of world events, Dodd-Frank implementation, and adoption of social media. Read the press release for more details.

Wednesday, May 4, 2011

PCFRC To Meet With FASB This Week

The Private Company Financial Reporting Committee (PCFRC), formed jointly by the Financial Accounting Standards Board and the AICPA in 2007 to advise FASB on matters relating to private companies vis-à-vis existing and proposed accounting standards, is slated to meet with members of the FASB board and staff later this week, in a public meeting which will be webcast.

The PCFRC will also meet with representatives of the Financial Accounting Foundation, which oversees the FASB. As previously reported, the FAF is conducting outreach on standard-setting for private companies, including with respect to the recommendations made earlier this year by a blue ribbon panel on private company standard-setting. See the comment letter filed by FEI's Committee on Private Company Standards (CPC-S).

The agenda, linked in the PCFRC meeting materials, notes there will be general updates and discussion of various FAF and FASB initiatives under way to study potential improvements in the standard setting process as relates to private company constituents, and more specific discussion of particular accounting standards.

George Beckwith, Chairman of FEI’s Committee on Private Company Standards (CPC-S), serves as a member of the PCFRC in his personal capacity, along with a number of other FEI members. (See PCFRC roster).

Monday, May 2, 2011

FASB Issues Accounting Standards Update On Repos

On Friday, the Financial Accounting Standards Board released an Accounting Standards Update on repos. The full title the document, ASU 2011-03, is: Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements.

As noted in FASB's press release:

The Update is intended to improve financial reporting of repurchase agreements
(“repos”) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.

The Board revisited its standards on transfers and servicing to respond to concerns from financial statement users who felt the criteria for determining effective
control for such transactions should be improved,” stated FASB Chairman Leslie
F. Seidman. “The new guidance improves transparency by eliminating consideration
of the transferor’s ability to fulfill its contractual rights and obligations from the criteria in determining effective control.”

In a typical repo transaction, an entity transfers financial assets to a counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. Topic 860, Transfers and
Servicing, prescribes when an entity may or may not recognize a sale upon the
transfer of financial assets subject to repo agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred financial assets.

The amendments in this Update are intended to improve the accounting for these transactions by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets, as well as implementation guidance related to that criterion.