Some obstacles to global financial reporting comparability and convergence at a high level of quality part 3

Some obstacles to global financial reporting comparability and convergence at a high level of quality

part 3

Comparability

1.4. Regulatory culture

Finally, we can discuss the regulatory culture
.

There are different traditions across countries as to whether a regulator, either in the private sector or public sector, should take a proactive, that is to say an aggressive, stance when dealing with companies’ financial reports destined for the securities markets and also addressed to shareholders.

In the USA, the SEC, which has some 3100 full-time staff and possesses a great deal of statutory authority to regulate the securities market, takes a very strong position on accounting matters. Some would say that the SEC is oppressive, and most countries would probably not accept a body comparable to the SEC as their regulator. Instead, in line with their regulatory tradition, many countries would prefer a lighter touch.

Therefore, the degree of regulation one sees in different countries can and does vary considerably. In countries where the regulator is stronger and more forceful, companies may be less willing to depart from a strict construction of IFRS, because the regulator will object and may insist upon changes in their financial reports. In countries where the regulation is softer, companies may be more inclined to apply their own constructions of IFRS, believing that the regulator would not take any adverse action. The strength of the regulation is important to worldwide comparability.

Certain factors can influence the strength of a regulator. How much authority did the Parliament or national legislature give to the regulator? What is the size of its budget? How competent a staff can it recruit, and what is the quality of its subsequent training? The regulator will, of course, be dealing with the finance directors of some of the most important multinationals in the country. Will its technical staff be up to the challenge? This is very important. In some countries, are there companies with enough political ‘clout’ that they might succeed in bullying or intimidating the regulator? Ultimately, the degree of a regulator’s pro activity in securing compliance with IFRS will be determined by the enforcement culture in the country.

Another point, which is relevant in Civil Code countries, is that the regulator may be unable to require companies to restate their financial statements once the shareholders, in their annual general meeting, have formally approved the company’s financial statements. Only the shareholders in another meeting or the judge in a Civil Court could alter the financial statements if a regulator were to object to some of the accounting practices used. In Common Law countries such as Canada, the USA, Australia, and the UK, when the shareholders hold their annual general meeting, they do not vote to approve the financial statements. The financial statements are those of the company management that prepared and issued them and are its responsibility, and if the regulator, such as the SEC in the USA, were to object to one or more treatments in the financial statements, it could instruct the company to make a ‘restatement’, that is, change each questioned treatment to one that is acceptable to the SEC (Zeff, 1995).

In the USA, we have had a great many such restatements in the last 5 years, especially since Enron. But even before Enron, the SEC routinely imposed a requirement upon companies to restate financial statements with which it disagreed. The SEC’s practice is for its staff to send the company a letter of comment, their commonly called a ‘deficiency letter’. The company responds, and the two parties engage in a dialogue, until, finally, after the SEC has heard the company’s defence of the questioned accounting practices, its staff decides whether the company must rectify its financial statements. When the SEC’s staff decides in favour of a restatement, every company makes the indicated changes in its financial statements, else it would risk losing its trading privileges on the stock exchange on which its shares are quoted. If a prospectus is involved, the SEC would prevent the Initial Public Offering from going to market unless the company were to make the restatement. In a minority of instances, the company will send representatives to a meeting at the SEC’s offices in Washington, DC, and the SEC staff’s decision would be made at the close of the meeting.

In the UK, the preference has been for a private-sector body possessing statutory authority, the Financial Reporting Review Panel, to approach listed companies whose financial statements are believed not to give a ‘true and fair view’ and to importune them to modify their accounting. Eventually, the Panel could take an offending company into the civil courts, but it has not, until now, gone that far. In some other countries, a section in the Ministry of Finance or a private-sector agency recommends that listed companies make changes in this year’s financial statements or perhaps only in next year’s financial statements. In a considerable number of countries even today there is no effective organ to monitor the accounting choices in listed companies’ financial statements. This issue of the vastly different regulatory environment from country to country has occupied much of the attention of the European Commission, the Committee of European Securities

Regulators (CESR), and the International Organization of Securities Commissions (IOSCO).

To Be Continued