Question

Do you think financial reporting plays any role in the capital markets? Explain in your own words.

Answer 1

The Securities and Exchange Commission was established in

the wake of the greatest financial disaster this country has

ever experienced. It was a time when substantial

investments had become worthless in a matter of hours and

days and when investors and the public had lost confidence

in impersonal securities markets.

The Securities Act of 1933, the Securities Exchange Act of

1934, and the other laws administered by the SEC1, were

enacted to ensure that our markets are fair and honest and

to provide the Commission and the courts with the means to

accomplish that objective. These laws, and related rules

and regulations adopted by the Commission, prescribe the

disclosures to be made in registration statements and

prospectuses used in securities offerings2 and in annual,

quarterly, and other public reports filed with the

Commission.3 The goal of the Commission's disclosure system

is to encourage and facilitate informed decisions by the

investing public.

In crafting the securities laws, the Congress recognized

that credible financial reporting is critical to an

effective disclosure system. Credible accounting,

supplemented by meaningful disclosures, provides the

transparency that enables investors to make meaningful

evaluations of investment opportunities. To provide the

mechanism to foster credible financial reporting, the

securities laws grant to the Commission the authority to

promulgate accounting principles for SEC registrants and to

prescribe the form and content of financial statements filed

with the Commission.4 The Commission also was given the

authority to define accounting terms.5

Relationship with Private-Sector Standard Setting

Practically since its inception the Commission has looked to

the accounting profession for leadership in establishing and

improving accounting principles to be used by public

companies.6 The Financial Accounting Standards Board (FASB)

is the private sector body recognized by the Commission to

perform that role today. Specifically, Commission rules

provide that financial statements prepared in accordance

with the pronouncements of the FASB will be considered to

have "substantial authoritative support," and those that do

not follow those standards will be considered to have no

such support and to be misleading.7

The Commission's willingness to look to the private sector,

however, has been with the understanding that the Commission

may exercise its statutory authority and override,

supplement, or otherwise amend private sector standards.

The Commission has exercised its authority by promulgating

rules in Regulation S-X and issuing interpretations in its

Financial Reporting Releases, and has overridden private

sector standards only on rare occasions. The typical

standard-setting activity of the Commission, however, has

been oversight of the private sector processes.

In addition, the Commission staff plays a significant role

in the financial reporting of registrants through its day-to-

day monitoring of practice. Our objective is to promote

consistent interpretation and application of standards and

to see that inappropriate or inconsistent practice is

identified and addressed on a timely basis. When practice

issues arise that are not addressed by existing

authoritative guidance, and time permits, the staff may ask

established standard-setting bodies or an interpretive

group, such as the FASB's Emerging Issues Task Force, to

address those issues. Alternatively, the Commission or its

staff may act directly by issuing a rule proposal or a Staff

Accounting Bulletin.

Involvement in International Standard Setting

I hope my remarks thus far have provided a sense of the

Commission's perspectives on financial reporting. With that

backdrop, I now turn to the international scene. Looking

back, the last decade was a time of significant change

worldwide -- change that has had tremendous implications for

the world's capital markets. Events like the break-up of

the Soviet Union and the reunification of Germany, for

example, have created major new demands for capital and,

therefore, new investment opportunities.

Significant privatization efforts, in countries as diverse

as Argentina and the UK, have created other demands for

capital. Established global companies also have been

reaching outside their home country capital markets as they

seek to meet their financing needs. At the same time,

changes in technology have reduced the constraints of time

and distance, with telecommunications and computers linking

people and markets all over the world.

These and many other forces have created a climate in which

capital flows across borders more readily, with fewer

logistical or regulatory restrictions, and where investors

have broadened their horizons beyond national borders. As

capital markets around the world continue to develop,

companies seeking capital will look for the best possible

terms, and investors providing capital will seek to compare

investment opportunities. As these trends continue, the

need for a common, high quality financial reporting and

disclosure framework can be expected to become more intense.

In pursuing a goal of common international accounting

standards, however, we must not lose sight of the investor

protection mission that has been the foundation of the

Commission's public mandate.

For the past several years, the International Organization

of Securities Commissions (IOSCO), of which the SEC is a

member, has been working with the International Accounting

Standards Committee (IASC) in an effort to improve the

IASC's standards so that they might become the framework for

accounting standards to be used in cross-border offerings.

Last April, the Commission released a statement of support

for the efforts of IOSCO and the IASC and indicated that, if

the IASC successfully completes an agreed-upon work plan,

the Commission intends to consider allowing foreign issuers

to use IASC standards in securities offerings in the US.

Importantly, the statement identified three key elements

that, in the Commission's view, are necessary for the IASC's

standards to gain that acceptance.

A Core Set of Standards

The first key element identified by the Commission is a

requirement that the standards include a core set of

accounting pronouncements that constitute a comprehensive,

generally accepted basis of accounting.

In 1994, IOSCO reviewed the existing IASC standards and

identified 14 completed standards that, with certain

reservations, would be considered acceptable core standards.

IOSCO also identified those standards that had "essential

issues" still open -- issues deemed critical by some

countries that need to be addressed before acceptance of

IASC standards can be recommended.

In July 1995, IOSCO and the IASC agreed on the work plan

referred to in the Commission's April 1996 statement, and in

April 1996, IASC announced an intention to accelerate that

plan with the objective of completing the core standards by

March 1998.

Comparability and Transparency

The second condition established by the Commission is that

the standards must be of "high quality" -- they must result

in comparability and transparency, and they must provide for

full disclosure.

When I speak of comparability, I have two meanings in mind:

* First, I mean that each company should prepare its

financial   statements on a consistent basis, so that

investors can   meaningfully analyze performance across time

periods.

* Second, I mean that reporting by different companies

should   be comparable, so that investors can make

meaningful comparisons   among investment alternatives.

High quality accounting and disclosure that provides

comparability and transparency is an absolutely essential

ingredient for well-informed capital allocation decisions

and market integrity. In the US, a critical factor in

measuring quality and, therefore, success will be the

acceptability of IASC standards to US investors and

investment analysts. I believe that acceptability to that

audience inevitably will depend on how well IASC standards

measure up when compared to US GAAP.

Rigorous Interpretation and Application

The third key element for success is the need for rigorous

interpretation and application of the accounting standards.

The IASC recently discussed this issue and agreed at its

last meeting to establish an interpretive body -- the

Standing Interpretations Committee. That is an encouraging

step, and while agreeing on how international accounting

standards are to be interpreted and applied will be

difficult and, at times, contentious, I believe that an

effective interpretive process is critical to achieving

meaningful international harmonization.

IOSCO had encouraged the IASC to take this step, in part,

because already we have seen diverging interpretations of

existing IASC standards. Let me give you an example.

International Accounting Standard (IAS) 22 addresses the

accounting for business combinations. Like other non-US

accounting standards for business combinations, it limits

the application of "uniting of interests" accounting, which

in the US we call "pooling of interests" accounting, to the

"rare situation" in which an acquirer cannot be identified.

The guidance of IAS 22 lists several means of identifying an

acquirer, starting with the combining shareholder group that

receives the majority ownership interest in the combined

entity.

The staff of the Commission believes IAS 22 is clear --

uniting of interests accounting would be appropriate only

when there is virtually a 50:50 split between the ownership

interests of the shareholder groups of the combining

companies. Yet, we have heard arguments for uniting of

interests accounting in circumstances in which the

shareholder group receiving the majority ownership interest

in the combination is clear. In one case, the consideration

received by the respective shareholder groups was split on a

70:30 basis. We have been told that IAS 22 has been

interpreted in other countries to permit uniting of

interests accounting in such circumstances when other

qualitative factors were considered. Such an

interpretation, in my view, fails the third benchmark for

rigorous interpretation and application.

If accounting standards are to satisfy the objective of

having similar transactions and events accounted for in

similar ways, whenever and wherever they are encountered,

auditors and regulators around the world must insist on a

consistent application and interpretation of those

standards. Otherwise, the comparability and transparency

that is the objective of common accounting standards will be

eroded.

Other Proposals

Some in the US are suggesting that the Commission should

consider other approaches to increasing access to our

markets by foreign issuers. For example, some have urged

the Commission to relax its reporting requirements for

selected "world class" foreign companies and allow those

companies to list in the US without supplementing their home-

country accounting and disclosures. Proponents of this

approach argue that, by segregating those companies on a

separate list, investors would be adequately warned of the

additional risks that could arise from incomplete

disclosures. Another argument made to support this approach

is that it will bring US investors, currently trading

outside the safety of US markets, back "on-shore."

I have serious concerns about that approach. It suggests a

return to the "caveat emptor" market that prevailed 65 years

ago. Underlying the Commission's participation in the IOSCO

and IASC initiatives to improve international accounting

standards is a strong belief that the success of US capital

markets is due in large measure to the high quality of

accounting and disclosure standards used by US public

companies. Those standards give investors confidence in the

credibility of financial reporting in the US -- an essential

ingredient that we cannot afford to compromise.

The US accounting and disclosure system supports -- indeed,

makes possible -- the deep and far-reaching tradition of

participation by individual investors in our capital

markets, because it enables all investors to have access to

robust financial information about public companies. The

willingness of individual households to invest in stocks and

bonds creates a much larger pool of investor funds in the US

than anywhere else in the world. Recent articles about

efforts in Germany to encourage individuals to subscribe for

Deutsche Telekom stock, for example, have observed the lack

of experience with individual ownership of equity

investments in that country.8 In some countries, including

some industrialized nations, stock markets remain embryonic,

and industry relies instead on banks and insurance companies

for capital.9

I fear that loosening reporting requirements for selected

foreign filers, though "world class" they may be, could

discriminate against individual investors and risk loss of

investors' confidence in US capital markets. There is some

evidence that, as foreign registrants gain experience with

the US system of reporting, managers are finding that the

costs are not as high as they feared, and the benefits are

greater than they expected. Professor Louis Lowenstein, in

a recent article in the Columbia Law Review, noted that

senior officers of two US-listed foreign registrants

"reported a long list of managerial gains from improved

financial disclosures... [including findings that] they have

found it easier to manage the company intelligently.... Not

surprisingly, they also reported greater access to world

capital markets and better stock prices reflecting greater

confidence on the part of investors."10

Commission Objectives

Let me complete my remarks about international harmonization

by commenting on what I believe are some misconceptions

about the Commission's participation in the IOSCO and IASC

initiatives. First, we are not attempting to coerce other

capital markets around the world to accept US GAAP.

Adoption of US accounting standards is not the only method

of achieving high quality financial reporting. We are

seeking to encourage credible capital markets grounded in

transparent financial reporting standards of comparable

quality to US GAAP. Conversely, this is not about replacing

US GAAP with international accounting standards. US GAAP

is, and we want it to remain, an integral component of the

success of the US capital markets.

Third, it is important to remember that the Commission has

not already agreed to accept IASC standards in filings in

the US. That question will be decided after the IASC's core

standards project is completed, based on the substance of

those standards. The key elements to Commission acceptance

of IASC standards that I described earlier will be critical

to that decision. Finally, we view the development of

accounting and disclosure standards for use in cross-border

filings as a long-term process. The IASC's efforts to

complete a core set of accounting standards is the next

important milestone, not the end of the road.

There is no question that the success of this initiative

will require an unparalleled degree of cooperation among

standard setters and regulators around the world. Reaching

agreement on internationally accepted accounting standards

involves a process of reconciling the interests of different

business, professional, and regulatory cultures and systems,

and we must acknowledge that the prospects for success are

uncertain.

The process, however, also can be a rich source of new

analysis and approaches to problems. We need to be willing

to evaluate the proposals objectively, measuring them not by

whether they are identical to US GAAP, but rather by how

well they would resolve accounting and disclosure problems.

As the process continues, we remain firmly committed to the

proposition that, to be accepted in US capital markets,

international standards must result in credibility and rigor

comparable to that produced by US standards.

Role of the FASB

I want to emphasize that our involvement in initiatives to

improve financial reporting in cross border filings does not

conflict in any way with our commitment to the continuing

improvement of accounting standards and financial reporting

in the US. Indeed, the FASB has had, and will continue to

have, a leadership role -- not only by establishing

credible, conceptually sound accounting standards for US

issuers, but also by participating in, and influencing the

outcome of, international standard setting efforts. Another

important role for the FASB is to seek opportunities to

harmonize standards developed in the US with those developed

internationally, without sacrificing the quality of

financial reporting that US investors enjoy today and will

expect in the future.

The US can make a tremendous contribution to the development

of international accounting standards. We have, on the

whole, the most successful private sector standard setting

process in the world. Through the FASB, as well as the

efforts of the Commission, we have the opportunity to help

shape the development of accounting standards

internationally and to help assure that investors around the

world receive the credible financial information they need

for making decisions.

Conclusion

I will conclude with these thoughts.

The US Congress created the SEC to restore and maintain

investor confidence after the 1929 stock market crash. The

Commission achieved that goal by assuring investors that, in

our markets, their interests would come first. This policy

is often summarized as a commitment to investor protection.

Much of the success of this policy can be attributed to a

regulatory system that incorporates the basic principle of

full disclosure, supported by strong market oversight and

vigorous enforcement. Because of that commitment, investors

have confidence in US capital markets. And, because

investors have confidence in the integrity of US capital

markets, they are willing, to an extent unmatched in any

other country, to invest their savings in our capital

markets.

If we want US capital markets to be as successful in the

future as they are today, then we must continue to build on

our strengths -- market integrity and investor confidence.