SEC Discusses Advancing the Capital Markets with High-Quality Information

Thank you for the kind introduction.  I’m grateful for the opportunity to speak at this financial reporting conference for the second time.

Before I continue, let me remind you that the views expressed today are my own and not necessarily those of the Commission, the individual Commissioners, or other colleagues on the Commission staff.

Let me also express a word of gratitude to the entire OCA team for their work in providing advice to the Commission regarding accounting and auditing matters arising in the administration of the federal securities laws.  I want to also acknowledge their valuable assistance in preparing me to make today’s remarks, including Robert Sledge, Emily Fitts, Sylvia Alicea, Ying Compton, Susan Fennedy, Karen Liu, and Sean May.

Our Shared Work Benefits All Americans

I think it is fitting to talk about the importance of our shared work in the public interest here at Baruch College, which traces its history back to the establishment of the Free Academy in New York City in 1847.  From its very beginning, this institution had a public interest mission, and this was demonstrated in part by admitting students from families engaged in a wide variety of trades and professions that were common at that time: butchers, carpenters, laborers, blacksmiths, and clergy.[1]

The work of the SEC staff, as well as that of the accounting profession, also has a broad set of beneficiaries.  Our collective work benefits savers and workers, including teachers, factory workers, farmers, nurses, members of our military, and veterans, as well as many others.

From the SEC’s perspective, working in the public interest has been integral to our three-part mission to protect investors, to maintain fair, orderly, and efficient markets, and to facilitate capital formation.

In that spirit, I will share with you some current issues that I think we all should approach from the perspective that high-quality information leads to better decisions for participants in our capital markets.

Implementation of the New Revenue Recognition Standard

The new revenue recognition standard will provide significant new information for investors, and in March 2017, I gave a speech that focused on its implementation.  I will not repeat those messages today, but please feel free to visit our SEC website for those comments.[2]

That being said, I did want to share a couple observations about the revenue implementation progress that has been made to date.

First, while we understand that some companies might be behind schedule in their implementation progress, I want to acknowledge the many companies that have been working very thoughtfully through their implementation and that have made significant progress on their implementation plans.  We understand that certain companies have substantially completed their accounting analyses, are in process of thoughtfully analyzing and considering the required disclosures in the standard, and are also focused on developing sustainable processes and internal control over financial reporting.  These companies should be commended for their efforts, and I believe the diligence that they have demonstrated in implementing the new revenue standard will both benefit investors, and serve as a good model for all companies as the profession continues to implement other major GAAP standards over the next few years.

Second, I want to emphasize the importance of the disclosures in the new revenue recognition standard.  There are a number of significant new disclosures, and for some companies, getting ready to prepare them might be one of the more challenging parts of the implementation process.  We understand that for some companies, preparing the disclosures constitutes a separate work stream in their implementation plans.  We have further observed that some of these disclosures may require coordination and interaction with various parts of the organization in order to compile the required information.  My message today is simple – I would continue to urge companies to not wait until the end of the year before trying to get the data, systems, processes, and controls in place to make these disclosures.  These disclosures are an important part of the new revenue standard for investors, and we urge companies to treat them as such and to allocate the appropriate time and resources to them.

OCA staff intends to continue to speak about the new revenue recognition standard at other forums throughout the year, and OCA of course stands ready to consult with registrants on their specific fact patterns on a pre-filing basis.

Implementation of the New Credit Losses Standard

We are also closely monitoring the implementation activities for the new credit losses standard.

I am looking forward to the next public meeting of the Transition Resource Group (TRG) for Credit Losses.[3]  I commend the stakeholders who took the time to make their submissions to the TRG.

It is important to a successful implementation that stakeholders continue to invest the time and effort to identify any issues and submit them to the FASB staff for consideration for future TRG meetings.  Implementation questions related to this critically important standard need to be discussed in an open and transparent forum so that all stakeholders can have confidence in the process and can learn from the discussions among a diverse group of interested parties.

I want to acknowledge the work that the TRG for Credit Losses, the AICPA Depository Institutions Expert Panel, and other industry groups have already done in this area.

Independence of Standard Setting

I want to emphasize the value of our accounting standard-setting process.  The responsibility for setting accounting standards for public companies was entrusted to the SEC more than 80 years ago, and, for nearly 45 years, the FASB has served as our U.S. private sector standard-setter.  This long history of coordination and collaboration between the SEC and the FASB has served investors and our markets well.

Farsighted business leaders have supported the independence of the process and accepted even those standards that may have worked against their short-term interests.  At the same time, Congress and the SEC have taken steps to ensure the independence of the accounting standard-setter because general acceptance of accounting standards used in our markets requires it.  For investors to place full confidence in them, accounting standards must be perceived as being above political concerns, commercial interests, influence of special-interest groups, or bureaucratic convenience.

So it was with concern that I heard recently of some advocating for implementation of the new credit losses standard to be put on hold, pending an analysis of its long-term macroeconomic effects.

The FASB, as an independent standard-setter for financial accounting and reporting standards, conducts an inclusive standard-setting due process that invites all constituents to voice their concerns with standards.  If an individual or a group does not like the direction or the outcome of the FASB’s standard-setting due process, they have appropriate forums to express their disagreement or doubt about an accounting change.  However, at times it can appear that the methods used to express such disagreement or doubt could serve to undermine the independence of the FASB and its due process, and could distort the objectives of general purpose financial reporting standards.

We all can remember the pressures at work when the FASB required stock options to be expensed, just to name one example.  The profession has been proactive in defending the independence of the FASB and its standard-setting process, which I hope continues.

The FASB developed the new credit losses standard in response to the needs of investors for more timely information about credit losses.  By better anticipating credit losses, loan loss provisions under the new standard can provide investors with more timely information about the risks and economic conditions that affect providers of credit.  It is well established in academic research that more transparent financial reporting reduces investor uncertainty about company prospects, leading to a lower cost of capital.[4]

We should all keep in mind that the new credit losses standard applies to all industries, and banks are both providers of credit loss information when they report GAAP financial information as well as users of that information when their underwriting process considers information in a potential borrower’s GAAP financial statements.

If there are questions about implementing the accounting requirements of the new standard, then the FASB is the right body to address them.  Banks can and should support the implementation process by identifying issues and submitting them to the TRG for Credit Losses, listening to those meetings, and being willing to participate.

It is critical that we get implementation of this standard right, and the time has come for us to focus our efforts even more towards achieving that objective.

IFRS and Foreign Private Issuer Consultations

High-quality information benefits the capital markets for both domestic as well as foreign private issuers.  IFRS continues to be an important subject for OCA, and I detailed my views on the use of IFRS in the U.S. last December.[5]

Many U.S. investors and companies continue to have an ongoing interest in the quality of IFRS, as they produce and use financial information prepared in accordance with IFRS on a regular basis.  Consequently, knowledge and understanding of IFRS, including similarities and differences between U.S. GAAP and IFRS, are highly relevant to U.S. stakeholders.  Reduced differences between U.S. GAAP and IFRS make these processes considerably more effective and may lead to higher quality financial reporting by U.S. companies.

Because IFRS is of significant importance to both U.S. investors and companies, the U.S. has a strong interest in monitoring the quality of IFRS Standards.  OCA monitors the governance of the IFRS Foundation and the IASB, the development of IFRS Standards, and the quality of the application of IFRS Standards through participation on several bodies including the IFRS Foundation Monitoring Board, the IFRS Advisory Council, the IFRS Interpretations Committee, and also through our participation and leadership role on IOSCO’s Committee on Issuer Accounting, Audit and Disclosure.

Today, over 500 foreign private issuers (FPIs), representing trillions of dollars in aggregate market capitalization, report to the SEC without a reconciliation, which makes the U.S. one of the largest markets for the securities of IFRS-reporting issuers.  In addition there are over 300 FPIs that file with the SEC using U.S. GAAP.

OCA regularly consults with U.S. registrants on matters involving the application of U.S. GAAP and IFRS, including some recent consultations with U.S. multinationals on the accounting policies they plan to adopt for the new revenue recognition standard under both Topic 606 and IFRS 15.

We have not observed the same level of consultation activity originating from foreign private issuers that file with the SEC using IFRS or U.S. GAAP.  There may be various reasons for this to be the case, but this is a useful occasion to remind all issuers that OCA’s consultation process is available to provide staff views on technical accounting positions.

Maintaining Frameworks for Internal Control over Financial Reporting

Maintaining effective internal control over financial reporting is essential to the production of high-quality information for investors.  While the Commission has not mandated the use of a particular framework to assess ICFR, most companies have selected the COSO framework.  In 2013, in response to changes in business and operating environments that occurred since the inception of the original framework, COSO issued the 2013 Internal Control – Integrated Framework,[6] which superseded the original framework published in 1992.  Although most registrants have made the transition to using the 2013 COSO framework, not all registrants have.[7]  I encourage those remaining registrants that use COSO to adopt the 2013 COSO framework.

In addition, I encourage stakeholders, including COSO, to monitor the evolving business and operating environments to determine whether updates to the control frameworks used in the evaluation of ICFR are needed.

Controls and Procedures for Other Reporting

Moving beyond the financial statements, in addition to reporting non-GAAP measures, many companies also disclose key operating metrics, forecasts, and other kinds of reporting, which may represent important sources of information for investors and supplement the information provided by GAAP.

I believe that much of the recent experience with non-GAAP financial metrics[8] also provides lessons for other kinds of reporting by companies.  Similar to non-GAAP financial reporting, key operating metrics and forecasts may also be distorted via bias – for example, painting a potentially misleading picture – error, or fraud, all of which undermine the credibility of the reporting.  Therefore, it is important that companies proactively and thoughtfully address risks to their reporting.

Companies should first understand the other information being reported, including how operating metrics are defined.

Companies then should have adequate disclosure controls and procedures in place.  In some respects, these other reporting processes may require more steps than some GAAP processes, not fewer.  This is because, for example, a company’s other reporting does not have the benefit of standard-setting due process, which solicits stakeholder views on a representationally faithful manner of reporting a particular event or transaction and the types of disclosures needed by financial statement users.  When a company determines a supplemental reporting framework, it does not have the benefit of a standard setter’s due process and must look to its own policies, audit committee, and other stakeholders for input.

Finally, companies should consider whether it would be beneficial to obtain insight into their other reporting processes from those outside of the finance and investor relations functions.  Sometimes a fresh perspective can provide new insight into potential risks and ways to maintain the effective operation of essential controls and procedures.

XBRL

Continuing on the theme of high-quality information leading to better decisions, I want to highlight a couple of developments regarding XBRL.

As part of its January 2017 order[9] regarding review of the FASB accounting support fee, the Commission requested that the FASB conduct an assessment of the efficiency and effectiveness of the U.S. GAAP Financial Reporting Taxonomy and report the findings, including suggested improvements, to the Commission prior to the FAF’s approval of the FASB’s 2018 budget and associated accounting support fee for review by the Commission.

In addition, in March 2017 the Commission posted the IFRS Taxonomy to its website, thus requiring foreign private issuers that report under IFRS to file XBRL financial statements with the Commission for fiscal years ending on or after December 15, 2017.[10]

Auditor Independence

Auditors play a vital role in the capital markets, in part, because of their impartial and objective judgment about financial reporting—reinforced by their independence.  Given the central role of independence in the auditor relationship, OCA monitors the application of SEC rules and guidance closely, including through consultations.

In this regard, there’s one particular area that my office has analyzed as part of these monitoring efforts.  A provision of the Commission’s independence requirements, often called the “Loan Provision,” generally provides, among other things, that an accountant is not independent when the accounting firm has any loan to or from an audit client, or an audit client’s officers, directors, or owners of more than ten percent of the audit client’s equity securities.[11]  As you may know, last year, the Division of Investment Management, in consultation with my office and the Division of Corporation Finance, issued a temporary No-Action Letter with respect to the Loan Provision regarding certain lending and ownership relationships as described in the letter.[12]  OCA is considering recommending to the Commission potential amendments to the Loan Provision to address the circumstances that gave rise to the need for the No-Action Letter, while continuing to ensure that auditors are independent of their audit clients.  At the same time, and in order to provide additional time to consider the issues raised, I understand that my colleagues in the Division of Investment Management expect to extend the relief provided by the No-Action Letter.

I will turn now to another issue of interest relating to the independence implications of proposing on non-audit services.

The Sarbanes-Oxley Act of 2002 mandates that audit committees be directly responsible for the oversight of the engagement of the company’s independent auditor, and the Commission rules are designed to ensure that auditors are independent of their audit clients.

OCA staff was recently consulted regarding whether an auditor could, prior to its dismissal, propose on prohibited non-audit services to be performed after the end of the audit and professional engagement period.  It is the staff’s view that, depending on facts and circumstances, this activity could potentially impair an auditor’s independence under the general standard in Rule 2-01(b) of Regulation S-X.[13]

Also, the proposal activity while the firm is still the auditor could adversely impact the auditor’s ability to maintain professional skepticism while conducting the audit.

Consistent with maintaining good oversight of auditor independence and performance, I encourage audit committees to engage with the auditor to understand the impact of any proposal activities for non-audit services on the auditor’s independence and audit quality.  This is particularly relevant in a period when an audit committee is considering auditor rotation.

As always, the staff is available to consult on matters of this nature.