Sunday, October 09, 2011

Former SEC Comm. and IASB Oversight Trustee Goldschmid Says US Incorporation of IFRS Is a ``National Imperative’’

It is a national imperative for the US to implement IFRS, said former SEC Commissioner Harvey Goldschmid, or risk becoming isolated in the area of financial accounting standards and no longer able to play the large and constructive role it now plays in IFRS development and oversight. In remarks at a recent AICPA-IASB seminar, the former Commissioner and current IASB oversight Trustee said that U.S. incorporation of IFRS would avoid regulatory arbitrage, make U.S. companies more attractive to foreign investors, reduce long-term financial accounting costs, and give investors a set of transparent high-quality global standards.

Indeed, he said that the best way to protect U.S. stakeholders, including investors who are increasingly global, is for the SEC to make an affirmative IFRS incorporation decision. While IFRS and U.S. GAAP are both of high quality, he noted , only IFRS has the prospect of global acceptance. The U.S.must remain an integral part of the IFRS process in order to assure the continued high quality of international accounting standards.

He also believes that effective enforcement would continue if the U.S. adopted IFRS. He posited that principles-based accounting standards can be better applied and enforced than detailed rules with bright lines and multiple exceptions. It is much harder for financial engineering to defeat a well-crafted principle than a detailed, specific rule, he emphasized. The modern principle-based approach has been incorporated into IASB/FASB converged standards.

However, he cautioned that even full U.S. incorporation of IFRS will not lead to perfect worldwide comparability of accounting standards. Great, not perfect, global comparability would occur if the U.S. commits to IFRS. But this quality difference is a limited problem, he added, and in fact may be a U.S. comparative advantage. The relatively high quality of US auditing standards and enforcement, for example, have reassured investors everywhere and have historically helped create a roughly 15% premium in value for foreign issuers that have listed on US exchanges.

While incorporation of IFRS principle-based standards would require more judgment than has been required in the past, acknowledged the former SEC official, under the antifraud provisions of the federal securities laws there is plenty of room to reach improper judgments and as importantly, to limit unfair, counterproductive litigation exposure. He finds comfort in a recent Second Circuit panel ruling demonstrating that judgment issues will be sensibly handled in US courts.

In the Fait case, noted Mr. Goldschmid, accounting judgments about goodwill and loan loss reserves were challenged by a plaintiff class. The Second Circuit, following much precedent and a classic Supreme Court case, he continued, summarily dismissed the claims because to be vulnerable the judgments had to be more than incorrect; they had to be disbelieved by defendants at the time they were made. Plaintiffs’ allegations in the case contained inadequate evidence of such disbelief.

The former Commissioner was referring to the Second Circuit panel’s recent ruling in Fait v. Regions Financial Corporation that an investor alleging that a company failed to write down goodwill in connection with an acquisition, and that its outside auditor falsely certified that the company financials were GAAP-compliant, did not state a claim under Sections 11 and 12 of the Securities Act since the statements regarding goodwill were subjective opinions rather than objective factual matters. Applying the US Supreme Court’s reasoning in the 1991 Virginia Bankshares v. Sandberg opinion, the Second Circuit panel ruled that the Section 11 and 12 claims failed because the investor failed to allege that the opinions on goodwill were both false and not honestly believed when they were made.

The IASB oversight Trustee also gave comfort to those who fear that US interests will not be adequately considered in the new global system. There are three basic safeguards in the IFRS system that will prevent that from happening, he said.

First, the IFRS three-tier governance model is similar to the process in the U.S. involving FASB, the Financial Accounting Foundation, and the SEC. This is no accident, he noted, since former Fed Chair Paul Volcker and former SEC Chair Arthur Levitt played large roles in shaping the IFRS governing model. The IASB is an independent, expert standard setting body. Since 2009, a Monitoring Board made up of 5 securities regulators, including SEC Chair Mary Schapiro, has provided a public accountability mechanism.

The basic idea is to balance the need for public accountability and for the independence of the standard setting process. The Trustee said that the appointment of only securities regulators to the Monitoring Board represents a determination that transparency, integrity, and investor protection must be the core values of the standard setting process.

Second, the IASB has a due process system that has been recognized as best practice throughout the standard setting and regulatory worlds. And the Trustees are set to approve a protocol to assuring the most demanding due process compliance throughout a project’s life-cycle from the placement of a matter on the Board’s agenda through the issuance of a standard. According to Trustee Goldschmid, the protocol contemplates: considerably enhanced outreach; more transparency throughout the standard setting process; a larger role for the IFRS Advisory Council, the IFRS Interpretations Committee, and national standard setters, more stringent cost-benefit analysis (called “effects analysis”); and post implementation reviews of the effectiveness of a standard. He said that U.S. stakeholders should be greatly comforted by this new emphasis on due process.

Third, further comfort can be found in the continuing roles envisioned for FASB and the SEC in the post-US IFRS incorporation world. He noted that FASB would have to evaluate and endorse an IFRS standard before it becomes part of U.S. GAAP. Given the size and importance of the U.S. financial markets, he said, this would give FASB the ability to influence the development of IFRS standards throughout a standard’s life-cycle. Speaking bluntly, the former SEC official said that the trick would be for FASB to use its endorsement power to protect U.S. interests when consulting with and advising the IASB, but when a standard is finalized by the IASB to endorse it except in the most rare and unusual circumstances.

The SEC would retain its ultimate authority under the securities laws to protect investors and prescribe accounting standards. The SEC would be actively involved in the international process, and as the SEC Staff Paper puts it, “monitoring of the standard-setting process, including the FASB’s role in the process, would be vital.”

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