What are the SEC’s requirements for non-US SEC registered entities?
The national GAAP financial statements of SEC (Securities and Exchange Commission) registered entities outside the US must include full US GAAP financial statements or a US GAAP reconciliation. In 2005, when EU-listed companies move to IFRS (International Financial Reporting Standards) in the primary financial statements, the SEC will still require a reconciliation with US GAAP. We hope that the regulator will ultimately agree that IFRS is a sufficiently robust, internationally accepted set of standards and that these companies can list in the US without reconciliation. However, if this happens, it is unlikely to be for several years.
How many years of comparatives do companies need to provide?
The SEC requires five years of financial statements, with the latest three years audited; IFRS requires only comparative financial statements. Many have urged the SEC to relax this requirement temporarily for first-time adopters. This will probably happen, but it is uncertain as to what other disclosures the SEC may require in its place. We can expect a decision by the end of the year.
What implications will the EU debate surrounding IAS 39 have on SEC requirements?
Companies will have to apply all IFRS standards to claim that their financial statements are compliant with IFRS. It is not clear what the SEC view will be on just using the endorsed standards. The SEC may not accept the primary IFRS financial statements of foreign registrants if IAS 39 is not endorsed. Companies wishing to list in the US will therefore have to adopt IAS 39 whatever the European Commission decides, unless the IASB says that a full set of IFRS financial statements do not have to include the application of IAS 39, but I cannot imagine this happening.
What is the position regarding the enforcement of IFRS for non-US companies listed in the US?
There is currently no IFRS regulator, although CESR (The Committee of European Securities Regulators) wants to take on that role. Until then, the SEC is acting as the IFRS regulator for its own purposes. It has historically questioned local GAAP positions and will do the same for IFRS going forward. European companies are not comfortable with this. The SEC sometimes interprets IFRS from a US GAAP, rules-based perspective and does not look at the standards in the way companies and auditors in the EU do. However, in the absence of another body to give the SEC its opinion, there will be a lot of focus on which reconciling items are acceptable to the SEC and which are not. For example, there might be valid differences between IFRS and US GAAP in revenue recognition, which has become more rules-based in the US over the last three or four years. The SEC may say there shouldn’t be differences between IFRS and US GAAP, forcing companies to take a rules-based approach when applying IFRS. The danger is that this will become ‘best practice’ if large EU entities with US listings are forced to do it.
What position should the auditors take if this happens?
There are a lot of cultural issues, politics and emotion wrapped up in this. One of the key points of IFRS was to have a principles-based counterpoint to US GAAP that would be acceptable in the global capital markets. If the SEC insists on putting its US perspective on the standards, it defeats the whole purpose. We return to the emotional debate of the US way of doing accounting versus the European way. It will be very interesting to see how this develops.
What other issues for foreign registrants will come to light in 2005?
The fact that transition to IFRS happens at all levels and not just head-office level may throw light on reconciliation differences that weren’t appropriately identified before the move to IFRS. For example, a company may come up with an answer that was correct under IFRS but find that it is different from the answer it came up with for US GAAP. Revenue recognition, loan loss reserves and impairment may be areas where you see this. The company will then have to restate. We can expect more US GAAP restatements in the future – I am already seeing evidence of this. While non-US registrants are dealing with the change to their accounting language in 2005, they are also going through the pain and suffering of compliance with Sarbanes-Oxley, Section 404. Some refer to this period as the ‘perfect storm’.
Section 404 requires companies to document and evaluate their control systems worldwide and then have their documentation and evaluation assertions audited, in addition to their financial statement audit. If you consider that companies may have to re-do key business and accounting processes worldwide to implement IFRS properly, at the same time as documenting and evaluating them, hiring an independent auditor to do additional work and issue an opinion on this control system, it is going to be a nightmarish situation.
Might companies fail to comply with SEC requirements on time?
Most companies will comply on time, but it is feared that corners may be cut at least initially, with companies inappropriately treating the process as an ‘evolution’ rather than a ‘revolution.’ Because of the difficulties of complying with the US rules, I expect that there will be an increasing number of companies seeking ways to de-list from the US, at least in the short-term. Some smaller mid-cap companies may decide that now is not the point in their company lifecycle to be US-listed. It will be interesting to see how many companies come back.