Investors, Small Companies and Regulators Sound Off

At SEC IFRS Roundtable On July 7

By Quentin Walsh

 

On July 7, 2011, representatives from several constituencies – the investor community (including analysts), small public companies and a variety of regulatory agencies – shared their views with the U.S. Securities and Exchange Commission at an SEC roundtable on the potential incorporation of International Financial Reporting Standards into the U.S. financial reporting system. Taking place at the SEC’s headquarters in Washington D.C., the roundtable was open to the public and webcast.

 

The SEC has held a number of roundtables on the subject of IFRS previously, and was particularly interested in reaching out for more feedback from these three groups of constituents, as the bulk of feedback the SEC receives (e.g. through comment letters) often appears to come mainly from large public companies and large audit firms.

 

As noted in a recent SEC staff paper released for public comment (detailed at the end of this summary), the SEC has not yet made a final decision as to whether, how, or when to incorporate IFRS into the U.S. financial reporting system.

 

Following are highlights from the investor, small public company and regulator panels at the July 11 SEC IFRS roundtable.

 

Investor Panel

The first panel of the day was focused on investor understanding and knowledge of IFRS. Panelists included:

• Neri Bukspan, Executive Managing Director, Standard and Poor's;
• Gregory Jonas, Managing Director, Morgan Stanley;
• Mark LaMonte, Managing Director, at Moody's Investor Service;
• David Larsen, Managing Director, Duff & Phelps Corp.;
• Mary Morris, Investment Officer, California Public Employees' Retirement System;
• Kevin Spataro, Senior Vice President, The Allstate Corp.; and
• Gerry White, President, Grace & White Inc. 

The panelists generally supported the establishment of a single set of high-quality financial standards that could be utilized around the world. The main benefit of a move to IFRS in the U.S., indicated the panelists, would be consistency and comparability across companies and industries. Hence there was agreement among the panelists that the SEC work plan was moving in the right direction to consider issues and ultimately adopt IFRS for U.S. companies.

 

There were a number of concerns raised about the structure and governance of the International Accounting Standards Board that need to be considered.

 

The focus of this investor panel seemed to be large companies, with an apparent underlying presumption that the primary users of financial statements are long-term investors who provide capital.

 

For example, noted the panelists, in making investment decisions, investors  start with audited financial statements that reflect the economic reality of transactions that have already taken place and they recognize that those past results may not be indicative of future performance.

 

In preparing valuations and recommendations, investors look beyond the financials and use additional information to build their projection of the future. The additional information will include footnote details, Management’s Discussion and Analysis and management discussions (such as discussions with analysts) and other sources. The due diligence conducted by valuation firms may seek a greater level of detail than is usually available in the basic financial statements.

 

This discussion of other information led to a "carve-in" suggestion. Currently, generally accepted accounting principles require greater disclosures in some instances, such as oil and gas reserves for an energy company. IFRS does not have those same requirements. Hence, it was suggested that in the U.S. we should expand IFRS requirements to provide at least the current level of detail.

 

As the discussion moved to the structure of the IASB, it was clear that there is a high level of confidence in the Financial Accounting Standards Board. Panelists observed that although constituents may not always like the outcome of some standards, the overall attitude was that FASB has reached a level of maturity, with stable funding, transparent deliberations and outreach to interested parties prior to reaching its decisions. It was also noted that FASB has clearly prioritized the needs of investors in the establishment of standards.

 

Conversely, it was noted that IASB has not reached this level of maturity. The funding sources are uncertain and the consideration of issues or need for interpretations is unclear. It was also observed by panelists that IASB is trying to accommodate other users of financial statements – such as government, labor and social groups. It is not clear if investors would be disadvantaged by the desires of these other groups.

 

It was also discussed that high-quality financial reporting is a three-legged stool, made up of high-quality standards, robust disclosures and rigorous enforcement. Panelists expressed the view that clearly, some countries are stronger then others in the review of company filings as well as the oversight of the audit firms.

 

Relative to investor knowledge, panelists noted there is a growing level of IFRS knowledge and expertise, but there will not be enough until a deadline for implementation is established, to provide the motivation to gear-up for a transition that was more certain to happen.

 

One of the observers, Tricia O'Malley, former chairman of the Canadian Accounting Standards Board, and a former member of IASB, O’Malley shared d a number of significant  insights on the current implementation of IFRS in Canada. One of her comments related to the work provided by industry groups to identify specific issues and drive common resolution of those issues.

 

All in all, one could leave the morning session (the investor panel) with the impression that IFRS conversion was inevitable. (Additional highlights from the investor panel can be found in the FEI blog here: http://financialexecutives.blogspot.com/2011/07/carve-ins-not-carve-outs-can-help-ifrs.html.)

 

Small Public Company Panel

The first afternoon panel focused on smaller public companies. Panelists included:

• Daniel Beck, Controller, Bank of the West;
• Shannon Greene, CFO, Tandy Leather Factory;
• David Grubb, Partner, Plante & Moran;
• Charlie Rowland, CFO, Viropharma;
• Bill Yeates, Partner, Hein & Associates LLP; and
• Ron Zilkowski, CFO, Cuisine Solutions.

 As soon as the opening comments started, it was clear that this panel of small public companies had little to no interest in adopting IFRS. Companies that operate solely in the U.S. would not receive any benefit from the change and would incur significant costs to comply, said panelists from such companies. Expanding on this view, they noted that given their small staffs, they would need to use consultants to get the work done. The effort and the costs would have to come out of the resources that could otherwise be used to improve and grow their businesses.

 

The regional accounting firms on the panel said they have some clients that have converted to IFRS, but expressed the view that the majority of their clients would receive no benefit from the change.

 

Panelists offered up a number of suggestions, including:

• The remaining major convergence projects on the FASB-IASB Memorandum of Understanding projects should be wrapped up before a decision by the U.S. on whether to incorporate IFRS. By converging the accounting on these major projects, building it into U.S. GAAP, the magnitude of IFRS differences will be minimized.
• The SEC needs to think through the entire process before setting an implementation timetable. A start-and-stop process would just waste everyone's time and escalate conversion costs.
• The availability of consultants will be critical. A short time schedule will create a shortage of the skills and expertise to accomplish the conversion work at these smaller companies.
• It is impossible to quantify the cost of conversion until more decisions are made. The status of the MoU projects, the timeline and other factors must be locked down before anyone can quantify the cost of the conversion.

O'Malley noted that some of the U.S. companies that have converted to IFRS may have been impacted by the Canadian IFRS conversion. Since many Canadian companies have subsidiaries and affiliates in the U.S., the parent companies have started requiring IFRS statements from all of their subsidiaries.

 

Although there appeared to be overwhelming support from the investors (mainly, analysts) on the morning panel, given the different points of view of the smaller public company and regional audit firm representatives on the second panel, it appears that the SEC’s upcoming IFRS decision will be challenging, and may not satisfy everyone.

 

Regulator Panel

The final afternoon session addressed the potential impact of a move to IFRS on the broader U.S. regulatory environment. Panelists included:

• Bryan Craig, Federal Energy Regulatory Commission;
• Rob Esson, National Association of Insurance Commissioners;
• Gaylen Hansen, National Association of State Boards of Accountancy;
• Kathy Murphy, Office of the Comptroller of the Currency;
• Nick Satriano, Federal Housing Finance Agency. 

Hansen expressed the view that IFRS is not a better regime than U.S. GAAP, and that we should not pursue an IFRS conversion. He pointed out three major reasons:

• The quality of IFRS standards are not significantly better than U.S. GAAP;
• Governance of IASB is not soundly established; and
• IFRS favors large accounting firms. A conversion will put smaller firms at an even greater competitive disadvantage.

Most of the input from this panel of regulators focused on the fact that the regulatory basis of accounting applied by those agencies is U.S. GAAP, with a small number of specific adjustments. A change to IFRS would require a review of the current rules by other regulatory agencies that currently rely on U.S. GAAP; the overall intent, if a move to IFRS were decided by the SEC, would be for the other regulatory agencies to use IFRS as the starting point with a small number of defined adjustments.

 

Sounding a note of caution, the regulatory panelists emphasized that the statutory financial information filed with them by companies have economic consequences, such as driving consumer utility rates, bank capital requirements and other matters. Therefore, panelists noted, care must be taken to understand the changes, to avoid triggering unintended utility rate increases, insurance rate changes or reduction in bank lending capacity.

 

Panelists also noted that many of the laws that impact regulatory actions have references to U.S. GAAP, or to specific U.S. GAAP treatment of transactions. Thus, a change to IFRS, in the view of these panelists, would create the need to go back to Congress to amend laws containing references to U.S. GAAP, to change those references to IFRS.

 

Based on comments made by these panelists, there appeared to be a concern about having to spend time or political capital in getting these technical changes through Congress.

 

Commenting on the legislative issue, O’Malley noted that Canada had a similar issue with regulatory language. As a result, Canada incorporated individual IFRS standards into Canadian GAAP, and Canada was thus able to avoid the need to make changes in its existing laws.

 

In summary, the SEC’s IFRS roundtable, which gave different groups of constituents the opportunity to discuss the implications of a potential move to IFRS in the U.S., has served the purpose of bringing to the surface many insights into potential IFRS conversion issues.

 

The SEC staff indicated that they will continue to follow their IFRS work plan and hope to present a recommendation by year end.

 

Some of the panel participants submitted their written statements to the SEC and those statements are being linked alongside the panelists names here. See also the SEC's IFRS roadmap comment file.

 

SEC Seeks Comment By July 31 on ‘Condorsement’ Approach

In a related development, the SEC is seeking comment on a staff paper released in May that centers on what is informally referred to as a possible “condorsement” approach to the ongoing incorporation of IFRS into the U.S. financial reporting system.

 

As noted in the SEC staff paper, “The commission has not yet made a decision as whether and, if so, how, to incorporate IFRS into the financial reporting system for U.S. issuers …

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.” Comments are due on the SEC staff paper on IFRS by July 31.

 

 

This summary was prepared by Quentin Walsh, CPA, a member of FEI’s New Jersey Chapter, who observed the roundtable proceedings first-hand in the public observers’ area. This summary does not represent the views of FEI unless specifically noted above.