Speech by SEC Staff:
International Convergence and Public Oversight of Accounting and Auditing Standards

by

Scott A. Taub

Deputy Chief Accountant; Office of the Chief Accountant
U.S. Securities and Exchange Commission

Amman, Jordan
May 20, 2004

Introduction

Good morning. I'm very happy to be able to speak with you today through the magic of modern technology, and I'm sorry that I'm not there to speak with you in person. The issues that are to be covered in this panel are issues that are all very near and dear to me, as they have taken up a large amount of my time in the past year and a half that I have been the Deputy Chief Accountant at the SEC. For the past year, I have also served as the Chair of Standing Committee No. 1 of the IOSCO Technical Committee. SC 1's mandate includes all things related to international auditing and accounting standards. My involvement with SC1 has really caused me to become aware of the high interest there is around issues concerning accounting and auditing. Of course, the International Accounting Standards Board and the International Federation of Accountants are interested, as are securities regulators all over the world. But it is the interest of organizations like the Basel Committee of Banking Supervisors, the International Association of Insurance Supervisors, the World Bank, the Financial Stability Forum, the Association of Investment Managers, and others that has really made it clear to me just how strong the desire is for high-quality accounting and auditing standards that can be used globally.

I'm happy to have a chance to share with you some of my thoughts on the issues involved in achieving convergence, in improving financial reporting and auditing, and on some of the recent events in these areas. Before I get started, I need to give a standard disclaimer and remind you that my views are my own, and do not necessarily reflect the views of the Commission, individual Commissioners, or my colleagues at the SEC.

International Convergence

Let me start by talking about the general topic of international convergence. I always say that, at a conceptual level, supporting convergence is pretty easy. Whatever transaction we're dealing with, it seems obvious to me that the best accounting for it is the same, whether the reader of the financial statements is in the US, the UK, Japan, or wherever. Similarly, the auditing procedures that are the most effective in the US are likely to be just as effective in Canada, China, or France. Disclosures relevant to investors in Italy, Greece, or the Middle East, are likely to be just as useful to investors in the US. And having one set of high-quality standards in any or all of these areas would benefit investors and reduce the administrative costs of accessing the capital markets around the world.

That being said, getting from where we are to where we would all like to be with respect to convergence is not easy. In order to realize the benefits of truly global financial reporting, we need convergence in all of the areas I just mentioned, accounting, auditing, and disclosures. And we need to work to enhance cooperation and consistency in regulatory review and enforcement, and to improve training and interpretive mechanisms as well. The amount of coordination necessary to do all of this is daunting, and much still needs to be done. But a lot is already happening, and I'd like to focus on some of those areas.

The IASB

By now, I expect everybody is aware of the work of the International Accounting Standards Board. The IASB is full-time, independent, standard-setting body. Its members are chosen for their expertise in accounting, and it operates in the sunshine with extensive due process. Its mission is to create a set of high-quality accounting standards that can be consistently applied worldwide. This is a difficult mission, but the structure and policies of the IASB are well-suited to achieve it. The IASB's standards, called International Financial Reporting Standards, or IFRS, will become mandatory for many listed companies in the EU and other jurisdictions beginning in 2005. This will be a huge step forward in terms of international convergence in accounting standards. One set of standards will be acceptable in something like 100 jurisdictions. This will be a great benefit to investors and other financial statements users worldwide.

To prepare for 2005, the IASB has had an ambitious program recently of improving its existing standards and putting out other standards to fill holes in its framework. Indeed, the IASB has substantially revised over a dozen standards, and issued 5 new ones, all in the past year. This flurry of effort was needed in order to make sure the body of IFRS that is adopted by so many listed entities in 2005 is robust, fosters consistency in reporting, and has as much internal integrity as possible. We should all commend the work done by the IASB to get ready for this process.

Reconciliation of IFRS to US GAAP

Having now said some nice things about the IASB and its standards, I feel it is necessary for me to acknowledge the question that I am always asked as a representative of the SEC when it comes to IFRS - are we going to do away with the requirement to reconcile IFRS financial statements to US GAAP in SEC filings, and when? In response to this question, I find it best to explain that the SEC's Office of the Chief Accountant treats IASB projects very similar to the way we treat FASB projects. We follow the projects, keep updated on the status through various means, discuss issues with the IASB staff, and basically seek to understand the proposals in detail. We also provide input to the IASB on issues to address. We comment on proposals, and we participate in IASB field studies as appropriate. I serve as an Observer to the IASB's Standards Advisory Council, and a member of my staff sits at the table at meetings of IFRIC, the IASB's interpretive body. We also commit substantial resources to IOSCO and SC1, whose focus is solely on international matters, including interpretation and enforcement of IFRS. In short, we are making sure we understand IFRS, so that we can enforce it as effectively as we do US GAAP, and we are doing what we can to ensure IFRS are of the highest quality possible.

So why are we doing all of this? The answer is easy -- we are preparing for a time when IFRS financial statements can be accepted without reconciliation to US GAAP. I absolutely believe that, if things continue as they have been going - if the IASB continues as a strong independent standard-setter in the manner that it has been, if the commitment to quality application of IFRS remains, etc. - we will at some point eliminate the reconciliation. The trickier bit is when. And I'll be honest - I don't know. But now that it is clear that the IASB is capable of and committed to putting out high-quality standards, and has strong expertise, independence and due process, the SEC staff is moving on to consider other issues that might stand in the way of dropping the reconciliation. One of the larger hurdles is that there are currently less than 50 US registrants that use IFRS for their primary financial statements. Obviously, that will change in 2005, and we need to be ready to address that, and to take advantage of the knowledge that can be gained from looking at such a large number of IFRS-based financial statements. We have committed resources to working on these issues, and I expect that we will continue to do so.

Convergence in Accounting Standards

In the meantime, however, the IASB and its US counterpart, the FASB, have been working towards making the reconciliation less onerous, by working to eliminate differences between US GAAP and IFRS to the greatest extent possible. The IASB and the FASB agreed formally in October 2002 to work towards convergence in their standards. The two Boards are now working together on several major projects, and they have essentially decided to coordinate agendas, so that any major project that one Board takes up will also be taken up by the other Board. In addition, the two Boards have been working on "short-term convergence", which involves quickly converging in certain areas to whichever Board's standard is better. That is, this process involves incremental improvements - instead of rethinking the issue entirely, the Boards look at the two existing models, and pick the better one. Many of the changes the IASB made in its recent amendments to previous standards accomplished this goal, and the FASB has put out 4 exposure drafts that would change US GAAP in certain areas to conform to IASB guidance that is considered to be better. At the SEC, we are constantly monitoring the reconciling items that exist in converting from IFRS to US GAAP, and providing information to the Boards to make sure they are aware of those differences that show up most often.

Clearly then, the prospect for convergence in US GAAP and IFRS is very good. In addition, the adoption or acceptance of IFRS in many jurisdictions in the near future means, of course, that convergence amongst all of those jurisdictions can also be achieved. That doesn't cover the entire world, but it is a great start.

As I continue to hype the benefits of convergence in accounting standards, I don't want you to think I would put convergence as a higher goal than improvement of standards. In fact, I look at every convergence project as an improvement project as well, because in converging standards, it is clear that the standard-setters will always choose the better existing model, or develop one that is better than all the previously existing models. Convergence to the lesser accounting model, what is often referred to as "lowest-common-denominator convergence" or a "rush to the bottom" would not be acceptable, and in fact, is not occurring. I do believe that the IASB, while seeking convergence, has done this without compromising the quality of the accounting standards being employed.

Interpretation and Enforcement of Accounting Standards

Many people, when talking about convergence, tend to focus on accounting standards only. But the application of those standards is equally important. Remember that, even when accounting standards are fully converged, the application of those standards will still be dependent upon accountants and auditors in every jurisdiction around the world. If the application various from country to country, from auditor to auditor, from industry to industry, etc., we will lose much of the benefit of having converged standards. Fortunately, there are many groups that are working to reduce the chances of this occurring. The IASB and its staff are helping, by designing training programs on IASB standards, by putting resources into IFRIC, the IASB's interpretive body, and by doing the best they can to write standards in a clear, concise, understandable manner. And the audit firms have taken up this charge as well. Each of the large firms has strong IFRS training programs, has put resources into developing a core of IFRS technical experts, and has been actively promoting IFRS whenever possible. All of these activities are important if IFRS is to be applied consistently worldwide.

Regulators also have an important role to play with regards to international convergence in financial reporting. This role goes to the interpretation and enforcement of accounting standards. Securities regulators must often determine, quickly, whether a company's proposed accounting is consistent with the relevant standards, in order to decide whether the company should be allowed to sell securities on the public markets. This issue is not new, as regulators have been dealing with similar issues related to national accounting standards for quite some time. Unfortunately, it is also not easy to deal with. Many would suggest that regulators leave interpretation of the standards to the standard-setter - to the IASB, in the case of IFRS. This, however, is not entirely a satisfactory approach. The standard-setting process cannot move as quickly as the capital markets, which means there will always be accounting issues that companies are dealing with that the standard-setters have not yet had time to address. In addition, if the IASB is to maintain its policy of keeping its standard are a fairly high "principles-based" level -- with less detail that might be the norm under US GAAP, for example -- it will be true that for some issues, the standard-setter will not provide guidance. If, in the absence of guidance from the standard-setter, the securities regulators are to accept any interpretation, investors will be subject to multiple conflicting applications, some of which may not provide transparent information. As a regulator, I do not find this to be acceptable, and I don't believe many other regulators would either.

So we will be in the position of making decisions regarding interpretations of the standards. With the same or similar standards being used in so many jurisdictions, there is the possibility that different regulators will have different views on the correct application of a standard. That type of situation would be detrimental to the capital markets, and would of course, undo some of the gains of convergence in standards. To mitigate against this possibility, regulators are working to develop processes that would encourage consultation amongst regulators, thereby reducing the chances for multiple interpretations. This issue has been a focus of the Committee of European Securities Regulators, and is also a focus of IOSCO Standing Committee No. 1. You can read CESR Enforcement Standard No. 2, which was released recently and addresses this very issue, for an idea of how regulators hope to address this risk.

Auditing

Let me switch to another key aspect of the international financial reporting structure, auditors and auditing standards. Much like accounting standards a few years ago, auditing standards still vary significantly from jurisdiction to jurisdiction. The recent high-profile auditing failures have, however, brought new focus to the important function of setting auditing standards, with many jurisdictions seeking ways to upgrade their standards and the frameworks within which they are set. Although the significant structural reform for auditing standards is behind similar reforms in the setting of accounting standards, you will soon hear from Rene Ricol about reforms that the International Federation of Accountants (IFAC), recently approved that make fundamental changes to the setting of International Standards of Auditing, which are used as the basis for many national auditing standards. The reforms were developed through a truly international dialogue amongst banking, insurance, and securities regulators, international financial institutions and other government bodies. As a result, ISAs will now be set by a body with increased independence, and subject to strong public interest oversight. These changes were necessary, as having the profession set auditing standards without strong oversight is really not viable in today's environment.

But IFAC's reforms are just a small part of the huge array of changes that are being made to the way that oversight of the audit profession is carried out around the world. The US has experienced about the biggest change in this area that could be, as the creation of the Public Company Accounting Oversight Board has turned the audit profession here from one that is largely self-regulated to one whose activities are completely overseen by an independent body. Many other jurisdictions are also implementing significant changes to the oversight of auditors. While the efforts to strengthen auditor oversight are ongoing in many places at once, the methods by which this is happening are different from country to country. The fact that complete convergence in the area of auditor oversight is not occurring is not surprising, however, given the complexity of the task.

In addition to the setting of audit performance standards, standards for auditor independence are inevitably a key part of any auditing structure. Other key aspects of auditor oversight regimes are quality control and assessment, and enforcement and discipline. Quality control programs usually involve some type of review of the workpapers from selected audit engagements. In some jurisdictions, this review is performed by the profession, in others, by an independent body, and in others, by a governmental agency. Enforcement and disciplinary programs are similarly run in different jurisdictions by professional bodies, independent regulators, and government agencies.

Beyond the areas elements of the auditing structure that focus on auditors, many jurisdiction are seeking to change the incentives of companies related to the preparation of financial statements by instituting management or director certifications, requiring independent boards or audit committees to select and oversee auditors, and by stiffening penalties for lying to auditors or preparing false financial statements.

My point in bringing up all of these issues with regards to auditor oversight is to emphasize that effective oversight of auditors is complicated, and there is not one agreed-upon method to accomplish it. I don't know what methods are the best ones. However, with all of the changes currently underway in this area, we will have the opportunity over the next few years to evaluate many different ways of accomplishing this task.

With auditor oversight regimes likely to differ amongst jurisdictions, a question of coordination arises. Given the increasing global nature of capital markets, and desire that many companies have to raise capital in multiple jurisdictions, it is important for regulators to work together to minimize duplicative regulation and to coordinate efforts where possible. In this regard, the recent EU progress on the 8th directive, covering audits, is an excellent example of how to achieve this. Similar efforts will no doubt continue to be made over the coming years.

Reluctance to Change

Over the course of the past 15 or so minutes, I have laid out a fairly long list of things that are being done to encourage improvements and convergence in international accounting and auditing standards. There are many people and groups that are very dedicated to these things, and are committed to making the various tasks happen. But there are some serious hurdles that could impact the achievement of these goals. I'm not gong to try to list all of the possible problems that need to be overcome, but I do want to mention what I believe to be the biggest hurdle that must be overcome. Although everybody is in favor of convergence in the abstract, many may be unwilling to change the way they actually do things solely in the name of convergence. I will use examples from my own jurisdiction, the US, to illustrate the different ways that this can arise.

First: I mentioned that there are 4 exposure drafts out in the US regarding changes to US GAAP that would conform US GAAP to IFRS in certain areas. By and large, the changes are in areas that were not perceived to be major shortcomings in US GAAP, nor are they areas where there was diversity in practice. The changes have been proposed now in an effort to achieve convergence. Some comment letters on these documents have indicated a reluctance to make changes in one or more of the areas covered. Respondents have suggested that these proposals should be put off because of the significant changes already being dealt with in the US financial reporting environment. Others have suggested that rather than adopt the IASB's model, the FASB should seek to find an all new, better model. These are honest concerns, and the FASB will carefully consider them, but they nonetheless impact the speed with which improvements can be made, and convergence can be reached.

In another example, consider the issue of what is commonly referred to as divided responsibility in group audits. The US is one of a very few jurisdictions that allow a primary auditor to disclaim, in the audit opinion, responsibility for a portion of the consolidated entity audited by another auditor. The collapse of Parmalat has brought this issue to the front of many people's minds. If convergence is to be reached in this area, it seems more likely that those jurisdictions that allow divided responsibility would change and prohibit it, rather than the other way around. However, there are several reasons cited in support of keeping divided responsibility, including the potential for increased liability to primary auditors, increases in audit fees, and less work available for local or regional auditors, as opposed to those affiliated with multinational firms. Again, these may all be honest and real concerns, but they raise hurdles to achieving the full benefits of one high-quality set of standards.

Finally, I would be remiss in not acknowledging the concerns that have been expressed in US regarding FASB's proposal to require the expensing of stock options. Many believe that expensing stock options will cause a loss of US jobs, or that valuation models for employee stock options are not sophisticated enough. The US Congress is considering legislation that would prohibit the SEC from recognizing as authoritative a FASB standard that requires the expensing of stock options. Again, the concerns are valid. But again, the consideration of these issues raises the possibility that we will not achieve convergence in this important area of accounting.

Conclusion

Despite the natural reluctance to change and all of the other problems that must be worked out, I am convinced that we are on a course that will lead to a financial reporting environment that will be characterized by high-quality standards and structures that are globally compatible with each other. The work that has been done to date on this goal by so many people is a testament to the importance of auditing and accounting to the global economy.

I will leave you with one further thought about the accounting and auditing environment. It is tempting to think of a single set of high-quality standards are destination that we are aiming for, but it is important that we all remember that the destination in question moves over time. 30 years ago, the conceptual framework for accounting standards didn't even consider fair value measurement as a potential choice. Now, of course, fair value is very often the preferred measurement. Similarly, it was once considered to be obvious that non-auditors could not write effective auditing standards. Now many jurisdictions are increasing the input of non-auditors into the audit standard-setting process. These kinds of changes are to be expected, and come about because we are constantly striving to improve standards to reflect the best thinking. So it is important to understand that accounting and auditing standards, oversight and implementation programs, and other relevant infrastructure elements will continue to evolve and improve over time. And that isn't a bad thing. Rather, it is part of the process of constantly improving things.

Thank you very much for your attention, and I look forward to discussion of these issues during the remainder of the panel.

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