Multiple regulatory demands cause companies to avoid US
Companies the world over are irked by the increasing number of national and industry regulatory bodies that need to be appeased and the duplication of rules that seems to follow. While this environment has increased the prosperity of some companies such as international law firms and banks with depository operations, most public companies are far from pleased with the need to deal with so many different accounting standards and regulators, many of which have remarkably similar rules.
For companies faced with multiple regulatory regimes, this has meant increased costs and energy, often so great that they have turned away from anything related to the securities business in a foreign country. This move can seriously affect capital-raising opportunities as well as restrict international expansion of business.
In the US, no fewer than three specially assembled groups reported in 2006 and 2007 that the US – particularly New York – was losing its place as the leader in world finance. Instead, London has emerged as the leading capital market, and regional centers are rising rapidly. Sparking concern in Congress, this change has put a lot of pressure on regulators to create ways to improved the attractiveness of US capital markets.
The SEC has routinely been criticized for its slow movement in helping to ease the burdens associated with regulatory overlap. However, it has started taking steps to correctly address these concerns, and now states that a concentrated effort is underway to make some progress that will save companies both time and money.
In late March the Commission made public its current stand and promised to move forward on several fronts. Notably, the Commission says it is aiming to make progress with a solid commitment to ‘mutual recognition’, meaning that a foreign regulator’s laws will achieve the same recognition as a particular US rule. The SEC will consider allowing a company from a foreign country to function or even publicly list in the US while continuing to operate under its national law, without necessarily having to strictly comply with some US rules and regulations.
Under any mutual-recognition agreement, non-US regulators will also be required to take a similar stance, allowing US-listed firms compliant with stock exchange and SEC rules to operate more freely in their markets. As one might imagine, establishing this kind of agreement requires lengthy and considerable negotiation. Yet it is hoped that as more countries agree, the pace of acceptance will increase, particularly among countries in similar regions. Most work in this area is currently being focused on the UK and on continental European countries. The SEC believes that by committing to this approach, it is moving up the global ladder in terms of development. Most importantly, as such agreements are obtained, the overall burden on companies from all jurisdictions and working under multiple regimes should decline, making international operations smoother and cheaper.
Progress is not proving to be too rapid. SEC chairman Christopher Cox outlined the major tactics in a speech earlier this year. ‘The most significant initiatives we expect to complete in 2008 are in the international and technology arenas. Mutual recognition, international accounting standards and interactive disclosure will all be the subjects of important rule proposals that will be presented to the Commission in late spring,’ he told listeners at the SEC Speaks in 2008 program of the Practicing Law Institute in Washington, DC.
As of mid-May only the proposal specifically discussing interactive reporting using extensible business reporting language (XBRL), the computer language that allows high-speed filings and disclosure along with comparisons and calculations across all data filed by companies at the SEC, had been set forth in any detail. Speaking at the end of April, Erik Sirri, director of the SEC’s division of trading and markets, reiterated the goals, adding that the framework for mutual recognition – a key starting point before fully engaging other regulatory regimes – still had not been agreed upon by the Commission staff.
Accountants leading the way
Nonetheless, observers see progress over a wider scale, particularly on the accounting front. ‘You have to separate between accounting, which has had more initiative in most respects, and non-accounting issues,’ says Richard Truesdell, an attorney with Davis Polk & Wardwell in New York. ‘The SEC has the path to convergence with US and international generally accepted accounting principles (GAAP); that area has shown the most significant progress to date.’ The US accounting regulators also have signaled a greater willingness to recognize the use of International Financial Reporting Standards (IFRS), and movement is afoot to merge the principles of the International Accounting Standards Board (IASB) with those of its US counterpart, the Financial Accounting Standards Board (FASB).
‘Other areas where regulatory regimes conflict like tender offer rules, have most often been dealt with on an ad hoc basis. Even before March, the SEC had been talking about broader arrangements with overseas regulators but developments in this area are still in more theoretical stages,’ Truesdell explains. ‘There is very little progress you can point to in terms of the establishment of a broad [financial market regulation] landscape. Things have mostly been dealt with as sort of one-off surgical remedies.’
Writing for the Cato Institute nearly 10 years ago, University of Virginia School of Law professor Paul Mahoney used similar words: ‘The SEC’s initiatives to date have been a series of ad hoc responses to pressing problems of overlapping or overreaching regulation rather than a comprehensive framework for avoiding such problems,’ he wrote, adding that the only way to achieve a truly global market was through the use of mutual recognition.
It is promising that the SEC has come around to his point of view. Truesdell observes the scene from his perch as co-head of capital markets at Davis Polk. ‘The mindset has changed,’ he says. ‘Now they understand the need for global regulation; they realize that in order to protect US investors, it is in everybody’s interest to have a more integrated global regime.’
Cox’s pronouncements last February and March put some meat on the bones of the overall plan. He referred to what he termed the three pillars of the SEC’s international strategy: mutual recognition, US GAAP and XBRL. Establishing mutual recognition as a dominant method of harmonizing with other jurisdictions is a thorny issue, as the concept requires balancing the need to protect local investors’ needs with the reality of globalized financial markets. In effect, the SEC is playing catch-up with some more advanced regulators, especially those within the European Union that have been able to establish fast-moving, efficient trading markets formed by excellent communications and deep pools of capital sourced from across the world.
The same rules for everybody
However, the issue of finding the natural solution to creating a single, super regulator remains the elephant in the room. Treasury secretary Henry Paulson has indicated that perhaps the Federal Reserve should have much more power as a financial services regulator, and this would relieve some of the country’s problems.
Yet this does not address the fundamental question of whether a single regulator to oversee the whole market, like the FSA in the UK could be beneficial. ‘In the longer term there will be a need for some sort of a super-regulator,’ Truesdell predicts. ‘That’s not a two-year time frame. Whether it is a five-year time frame depends on what steps are taken and how concrete they are going to be.’
Taking the first steps
The first mutual recognition arrangement might be with Australia. The SEC joined Australian Prime Minister Kevin Rudd in announcing joint discussions marking ‘the first step toward a possible bilateral arrangement, [which] will cover potential recognition to allow securities exchanges and markets participants to operate in each other’s markets.’
The SEC’s second pillar of international strategy is the project to converge US GAAP with IFRS. ‘Because of the significant progress that has been made in developing IFRS as a high-quality accounting standard – and in light of its rapid and growing acceptance around the world – the Commission last year voted unanimously to take the next step on the SEC’s roadmap announced three years ago,’ Cox said in early 2008.
As a result of that next step, some foreign issuers now can file their financial statements with the SEC using IFRS, without needing to keep a second set of books under US GAAP. The Commission will set forth this year a revised ‘roadmap’ that includes a plan to bring US companies into the loop by moving to accept IFRS-prepared financials from US companies.
The IFRS move affects US corporations elsewhere as well. Companies listing elsewhere could face a requirement to offer their financial statements using IFRS rather than US GAAP.
‘If the foreign jurisdictions are going to require IFRS, that imposes an additional cost on US issuers,’ notes Alan Paley, partner and co-chair of the securities group at Debevoise & Plimpton in New York. ‘By fostering convergence and reaching a point where companies are really multinational issuers, they can use IFRS at home and abroad. Then they don’t have those additional costs.’ Few non-US jurisdictions presently accept US GAAP, so it is likely that US companies are completing two sets of accounts. It is doubtless that a single accounting standard will make life easier in the long run.
Unification on the accounting side is a tricky thing to discuss let alone successfully accomplish, but it might not be that far off. In April, according to Kate Ashton, a Debevoise & Plimpton partner based in London, EU staff experts decided that US GAAP is functionally equivalent to IFRS. If their working paper results in an EU law, then US companies might not have to be concerned about an IFRS filing. What it all comes down to is that both sides are working toward each other at a fairly good clip.
Technology as the driver
The third pillar of the SEC’s international strategy, according to Cox, is making sure that all US companies are on board with XBRL. Cox has said ‘the adoption of a global computer language for the exchange of financial information goes hand in glove with the concepts of a common accounting language and mutual recognition of high-quality securities regulation.’
This year, he said, ‘following years of evaluation and experience through the SEC’s voluntary XBRL pilot program, the Commission will consider a rule for the use of interactive data by US reporting companies that will parallel efforts already underway in other countries.’ It was proposed in May.
Ashton points to another area of convergence: enforcement. ‘It is undoubtedly true,’ she says, ‘that the US regulatory structure is the most respected, or feared, in the world. That is because the SEC has the biggest budget for enforcement, and penalties are harsher than any EU jurisdiction.’ In his April 30 speech, Sirri stated that an integral part of the process moving toward achieving mutual recognition will require that the SEC ‘determine whether foreign markets and intermediaries are subject to comparable regulation in their home jurisdiction.’
There is much push and pull at work, both for the regulators and for the companies who might be reluctant to adopt changes such as XBRL. Yet capturing the efficiencies of the computerized filing and disclosure system, forming reciprocal agreements on accounting and regulatory matters, and establishing an electronic trading world all will lead to an ever-larger, more liquid global capital market.
