Hamlet at the SEC
Many are waiting to hear from the SEC about its current views on its much ballyhooed but inchoate flirtations to have US companies use international financial reporting standards (IFRS) and let non-US organizations use US markets without local registration if they are supervised by comparable regimes at home (mutual recognition). Earlier, in speeches, press releases and at roundtables, SEC official talk told us that we’d have formal delineation on these initiatives this summer. Action still may come, but there appears little doubt that efforts are delayed, talk is ahead of action and momentum is far ahead of concrete formulations.
Delay may reflect SEC realization that these initiatives are more difficult in practice than officials would like to believe. Or delay may reflect how the SEC is sidetracked by the credit turmoil, criticism of its oversight effectiveness, and Treasury Department proposals that would substantially reduce the agency’s regulatory role in the future. Either way, investors may benefit from the delay, for SEC statements to date on these subjects suggest approaches that subordinate investor interests in favor of interests of brokers, exchanges and issuers.
In its talk, the SEC offers only modest references to investor interests or investor protection. It repeatedly emphasizes, as benefits from moving to IFRS and mutual recognition, increased cross border capital flows. The SEC’s asserted benefits for investors often are strained. For example, it says that companies using IFRS will enjoy savings from financial reporting activities, thus freeing up funds for them to invest in productive business activity. That, the SEC says, will benefit investors.
True, increasing global capital flows can reduce the costs of capital and increase returns to investors. This can create a wider spectrum of investment opportunities from which to choose, adding to the possibility of portfolio diversification, risk management and risk-adjusted returns. In theory, IFRS and mutual recognition may have these effects and related benefits. In reality, there are serious challenges that are more likely to limit net investor benefits.
IFRS benefits depend on applications that yield actual comparability of financial statements across companies and countries. Believing in this result is like believing in the tooth fairy. Worse, SEC talk of comparability is likely to make the results worse by producing a false veneer of comparability disguising significant differences in practice. Mutual recognition depends on effective existence and enforcement of investor protection laws; meeting this requirement may be possible in a few countries, perhaps Australia and Canada, but that is a far cry from SEC talk of a “trans-Atlantic” or “global” capital market. And, along a road to mutual recognition with countries lacking investor protection traditions prevalent in the US, those traditions are likely to weaken in the name of investor choice.
This limited SEC attention to investor interests introduces a paradox and contradiction. Federal statutes require the SEC, in rule-making and policy formulation, to balance goals of investor protection and capital formation. Congress gives the SEC limited guidance on balancing these goals, granting changing SEC leadership discretion. On the other hand, in the Sarbanes-Oxley Act of 2002, Congress explicitly directed how the balance is to be struck, at least concerning accounting standards. It told the SEC to consider, when evaluating a standard setter, to determine that it has the ability to assist the SEC discharge its responsibility to protect investors. In its evaluations of IFRS to date, the SEC has given short shrift to this mandate. Indeed, the SEC seems to ignore legal constraints on its power to anoint IFRS as a recognized body of accounting for purposes of US securities laws.
The SEC, under current leadership and certainly on IFRS and mutual recognition ideas, appears more interested in managing how markets expand globally than with how to protect US investors at home or abroad. Inaction by this SEC on IFRS and mutual recognition may be a plus, given the tenor of its talk.