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SEC Chair Tackles U.S. Credit Crisis, IFRS and Much More

Source: Financial Executive; MorristownPublication Date: 2008-11-01Arrival time: Nov 21, 03:20 AM

When he leaves office - presumably by or before next June, when his term expires - Christopher Cox will be one of the longest- serving chairmen of the U.S. Securities and Exchange Commission. The average tenure of a chairman is two years; he'll have served for nearly four, if he makes it to next June. In the Q&A that follows, Financial Executive Editor-in-Chief Ellen M. Heffes spoke with Cox in early September about some of the commission's activities during his term and his role generally. She then went back to him closer to press time for an update about the SECs activities related to the U.S. credit-market crisis.

Q What role is the SEC playing and what do you see for the SEC in the current market turmoil and credit crisis?

Cox: Our role is to protect investors and maintain orderly markets in this crisis. Above all in the current turmoil, the markets and investors need transparency.

Market participants have had a great deal of difficulty in assessing and pricing risk throughout the credit crisis. Illiquid instruments that were recently rated AAA for credit quality, off- balance sheet vehicles that obscured risks, and uncertainty about mortgage-related asset prices in the current environment have worsened the problems that were initially created by poor lending standards and inadequate loan documentation and disclosure.

We have worked on a number of fronts to improve transparency, including using our new authority under the Credit Rating Agency Reform Act. The commission's proposed new rules governing every aspect of the credit rating agencies' disclosures and monitoring of its [the agencies'] conflicts of interest will be finalized very soon - as soon as the law allows.

The [SEC] Division of Corporation Finance has worked to broaden disclosure by financial institutions, including discussion and analysis by management, particularly with respect to off-balance sheet arrangements and hard-to-value assets.

These additional disclosures are useful to investors who need to understand in real time the financial position of the companies they own.

We have also worked on the accounting front, both in the United States - with the Financial Accounting Standards Board - and with our overseas regulatory counterparts, to deal with such issues as consolidation of off-balance sheet liabilities and the application of fair value standards in the current market turmoil. We have, on several recent occasions, provided real-time guidance to deal with issues such as the accounting treatment of bank support for money market funds.

Christopher Cox

chairman

U.S. Securities and Exchange Commission

We have been working in close cooperation with the Commodities Futures Trading Commission and the Federal Reserve to strengthen the over-the-counter derivatives infrastructure, including clearance and settlement, and the establishment of a central counterparty. These markets must be made more transparent and less vulnerable to failures in confidence in the event of financial difficulties at a major financial institution.

Q What resources axe the SEC devoting to these efforts?

Cox: First and foremost, of course, the SEC is a lawenforcement agency, and we have devoted an extraordinary level of enforcement resources to hold accountable those whose violations of the law have contributed to the subprime crisis and the loss of confidence in our markets.

We have over 50 pending lawenforcement investigations in the subprime area. Our Office of Compliance Inspections and Examinations has initiated examinations of the effectiveness of broker-dealers' controls to prevent the spread of false information intended to manipulate securities prices.

The [SEC] Division of Enforcement has undertaken a sweeping investigation into market manipulation of financial institutions, focused on broker-dealers and institutional investors with significant trading activity in financial issuers and with positions in credit default swaps.

The reason for this aggressive enforcement investigation is the significant opportunities that exist for manipulation in the $58 trillion CDS market, which is completely lacking in transparency and unregulated.

Last summer, the enforcement division, working with state regulators from around the country, entered into agreements that, when finalized, will be the largest settlements in the history of the SEC, in behalf of investors who bought auction-rate securities from Merrill Lynch, Wachovia, UBS and Citigroup. The terms of these agreements would provide complete recovery for individual investors. We are continuing to investigate other firms.

The effect of the subprime crisis on investment banks has been profound. The SEC recently oversaw the sale of substantially all of the assets of Lehman Brothers Inc. to Barclays Capital. This was accomplished just days after Lehman's parent company filed for bankruptcy; it brought immediate relief to Lehman's brokerage customers and the capital markets.

To maintain short-term market stability while the Congress crafted sweeping legislation to provide liquidity, the SEC took temporary emergency action to ban short selling in financial securities, working in close coordination with regulators around the world.

At the same time, the commission unanimously approved two additional measures to ease the crisis of confidence in the markets that threatened the viability of all financial firms, and which potentially threatened the ability of our markets to function in a fair and orderly manner.

The first makes it easier for issuers to repurchase their own shares on the open market, which provides an important source of liquidity in times of market volatility. The second requires large investors to report short positions to the SEC in addition to their current reporting of long positions on Form 13F.

Finally, the SEC is working with Congress to fill a significant regulatory hole: the $58 trillion notional market in credit default swaps. This market has doubled in size since 2006 - and it is regulated by no one. Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market.

This is an area that our enforcement division is focused on - using our antifraud authority, even though swaps are not defined as securities because of concerns that CDS offer outsized incentives to market participants to see an issuer referenced in a CDS default or experience another credit event.

Q An area where this SEC has been active is executive compensation disclosure. Are you satisfied with the new rules that went into effect last year? Did they go far enough? Will more rules follow?

Cox: Investors are getting, for the first time, all of the information about executive compensation in one place. Most significantly, the various forms of compensation are combined in one number that permits comparison from executive to executive, as well as across companies and industries.

The most significant future improvements in executive compensation disclosure will come from interactive data, which will make comparison even easier and improve narrative disclosure.

The SEC staff review in the Division of Corporation Finance has focused directly on the quality of explanation in the narrative portion of the executive compensation disclosure. In that respect, we are looking for clarity rather than length. Indeed, I continue to think that the disclosures are too long. If necessary, we will adjust our rules to ensure there's no mistaking our purpose.

Q In August, the five SEC commissioners voted unani"mously to publish a roadmap for potential U.S. adoption of International Financial Reporting Standards. By the time this interview is published, the SEC will have some comments. Overall, what's your thinking here?

Cox: Our objective is to ensure that financial reporting in the United States is comparable with financial reporting in other leading markets around the world for the benefit of investors. Until very recently, U.S. generally accepted accounting principles were the preponderant set of accounting standards in the world. Recently GAAP has lost the lead to IFRS, and the trend is unmistakable.

Today, all of Europe and nearly 100 countries around the world require or permit the use of IFRS, and many more are on the verge of doing so. In addition, many foreign issuers in the U.S. market are already reporting to American investors using IFRS.

For that reason, and because twothirds of U.S. investors own stocks in foreign companies, the U.S. has a strong interest in ensuring that IFRS becomes a truly high-quality set of standards that is uniformly applied from jurisdiction to jurisdiction. For several years now, the U.S. has invested both time and money in ensuring the ultimate success of IFRS - and we have a great deal at stake.

Because of the magnitude of the change, as Europe's shift to IFRS in 2005 demonstrated, we need a multiyear roadmap. So, the commission has proposed a roadmap that, if milestones along the way are met, would lead to U.S. companies beginning to use IFRS in 2014 - were the commission to make a final decision between now and then.

In the meantime, among the significant milestones that would have to be met are changes to the funding and regulatory oversight of the International Accounting Standards Board, including improvements in the governance of the International Accounting Standards Committee Foundation and IASB itself; progress in the continued work on convergence of U.S. GAAP and IFRS through the joint work of the IASB and the Financial Accounting Standards Board; and sorting out other unique issues such as the significant tax-reporting issues with the Internal Revenue Service. The SEC has worked with both individual national regulators and the International Organization of Securities Commissions - where I recently became chairman of the Technical Committee - to establish a monitoring group in which the SEC would participate along with other regulators to ensure that IASB standard setting is accountable.

Q IFRS will be an enormous change for preparers of U.S. financial statements as well as auditors, professors, students of accounting, etc. What changes do you expect at the SEC in the way filings are reviewed, etc.?

Cox: The SEC has been reviewing IFRS financial statements for some time, and we are gaining considerable experience and expertise in the process. The Division of Corporation Finance review process is very similar to that for U.S. GAAP filings, and we are currently in our third year of reviewing foreign private-issuer filings under IFRS. The roadmap, if adopted, provides additional years for the SEC to continue to develop that expertise and master the fine points of difference between GAAP and IFRS implementation.

Q Will the process differ with a Republican or Democrat in the White House in January?

Cox: No. There is absolutely nothing partisan about investor comparability and high-quality global standards. What has and will make a difference, however, is the overall climate in which these questions are being considered.

The market turmoil requires that regulators and policymakers give precedence to remedial initiatives, so that until there is a restoration of investor confidence it is likely we will not go beyond the convergence process.

And of course, while there is nearly universal agreement on the longterm objective of high-quality, truly global standards in which America participates, precisely how a roadmap might unfold over a 10- year period is difficult to predict.

One possible predictor, however, is the fact that the proposed roadmap calls for the first definitive decision by the SEC in 2011, when the terms of four of the five current commissioners who voted for the August proposal will not yet have expired.

Q What do you envision the SEC role with the monitoring group? And regarding U.S. representation: any concern that this body could become another United Nations, where U.S. interests are not necessarily in the majority?

Cox: The monitoring group for the IASC Foundation, which overseas the IASB, would be comprised of representatives of national securities regulators as well as IOSCO. It would play a role very similar to that played by the SEC with respect to the FASB.

Its purpose is to ensure that the global standard-setting group is independent. Accountability and independence are the yin and yang of success for the IASB. By independence, I mean independence from special pleaders, from the political process, from favored industries or industry players and from national and regional biases.

Q If by 2014 certain companies start filing, to have comparability of their financial statements, won't they have to file in both U.S. GAAP and IFRS? How did Europe handle this in 2005?

Cox: IFRS itself requires reconciliation in the year of adoption. In our proposal, we ask whether there should be reconciliation beyond the year of adoption. We are interested in acquiring information about the cost of providing additional reconciliation and the usefulness of that.

In Europe, they did it for one year.

Q What is the plan for smaller public companies?

Cox: The criteria for early adoption are focused on companies and industries where IFRS is already the dominant form of reporting. The idea is that even when it comes to early adopters, investors should be made better off.

So the first element of the eligibility criteria requires that IFRS be used in the company's industry more than any other set of standards. Were the commission to decide in 2011 to proceed along the lines of the roadmap, then beginning in 2014, the largest companies would begin to report. This would presumably further advance comparability because of the global nature of their businesses. Smaller companies would have more time to prepare.

Q With IFRS and a more principies-based approach to accounting and reporting, do you expect the U.S. legal environment to change?

Cox: The recent CIFiR [Committee on Improvements to Financial Reporting] recommendations, including those related to auditors' use of judgment, are instructive in this regard. Increasingly in the SEC's review and enforcement of standards under U.S. GAAP, we have focused on whether auditors operated within an acceptable judgment framework.

Did they research the relevant literature and precedents? Did they examine the practice of others? Did the choice they made fairly represent to investors the operations of the company? Those are the right questions, and not only for auditors to ask, but also for regulators.

Q Enforcement has been a big priority, and under your leadership, the SEC has set several enforcement records.

Cox: This past year and again in 2008-09, the SEC will have the largest enforcement budget in its history, and we are expecting in 2009 unparalleled support and results for investors. In the three years that I've been chairman, the SEC has set records for the greatest number of corporate penalties of any year in commission history, the second highest single-year total for penalties and disgorgement and the second highest number of enforcement actions brought in a single year.

The second-highest corporate penalty, against Fannie Mae in 2006, also came under that time period. And we've set the record for the highest ever financial sanction against an individual, against the CEO of United HealthCare, which was more than was assessed against junk-bond king Michael Milken. We've also cracked the biggest insider trading ring since the days of Ivan Boesky.

I'm particularly proud of the fact that our use of interactive data for Form 4 reporting of executive stock options enabled us to uncover the backdating scandals. As a result of that financial detective work, the SEC brought several actions that have all but stamped out stock option backdating in America.

Copyright Financial Executives International Nov 2008

(c) 2008 Financial Executive; Morristown. Provided by ProQuest LLC. All rights Reserved.

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