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LAWFUEL - The Law News Network: SPEECH AT THE LONDON SCHOOL OF ECONOMICS AND POLITICAL SCIENCE BY MR WILLIAM H. DONALDSON, CHAIRMAN OF THE US SECURITIES AND EXCHANGE COMMISSION: “For the past few years, much of the media coverage of business has revolved around financial scandals at some prominent, once-respected companies. You all know the list”: “Enron, WorldCom…”: “Over the past 18 months, we have seen many non-U.S. companies… Parmalat… Hollinger… Royal Dutch Shell… and others – accused of managerial fraud, accounting irregularities and other governance abuses.” ( Posted 26 Jan 05


January 25, 2005 - LAWFUEL - The Law News Network –


As Chairman of the Securities and Exchange Commission, I am obligated

to tell you that the views I express here are my own and do not necessarily

represent those of the Commission or its staff. With that formality aside,

let me begin with an observation that is sometimes heard in discussions

about liberalizing international commerce. Feelings about free trade, it’s

said, are the same as those about heaven – everyone wants to get there,

but just not too quickly!


I want to thank Howard Davies and the London School of Economics and

Political Science for hosting this event, and for giving me the opportunity

to speak today. It is an honor and a pleasure to be at an institution with

such a rich and varied history, serving as a place of study or research for

13 Nobel Prize winners, including Friedrich von Hayek; more than two dozen

heads of state, including John F. Kennedy; and one former student in a

category of his own: Mick Jagger!


We are all familiar with the dramatic expansion of global business and

foreign direct investment in recent years. But less well understood is how

national regulation impacts the world’s securities markets, and the

importance of regulatory coordination and cooperation among the world’s

securities regulators. Given the substantial amount of cross-border

holdings, capital flows, and transactions such as mergers and acquisitions,

all regulators have much to learn from their foreign counterparts.


Indeed, while the SEC is proud of the regulatory system in the United States

and the work we do to maintain and constantly improve it, I am the first to

acknowledge we don’t have all the answers. We are anxious to listen to, and

learn from, ideas advanced by other regulators, which is one reason why the

SEC is an active member of IOSCO, the International Organization of

Securities Commissions. In the same vein, we also seek to hear from all

manner of interested parties, to advance a constructive dialogue and to

maintain strong and vibrant capital markets – in the United States, in

Europe, and throughout the world.


In that spirit I’d like to talk today about a number of pressing issues

facing securities markets throughout the world, with an emphasis on the

comprehensive U.S. corporate-reform law of 2002, the Sarbanes-Oxley Act –

looking at how it’s working, how it affects foreign issuers, and what we’re

doing to ensure a level playing field in the U.S. market for all issuers,

regardless of country of origin.


For the past few years, much of the media coverage of business has revolved

around financial scandals at some prominent, once-respected companies. You

all know the list: Enron, WorldCom, Adelphia, Health South, Tyco, Global

Crossing, Cendant and others. In the beginning, these financial scandals

appeared to be primarily an American phenomenon — perhaps a result of

overheated U.S. stock markets, excessive greed, and a winner-take-all

business mindset. More recently, however, it has become clear that U.S.

companies were not alone when it came to scandals. Over the past 18 months,

we have seen many non-U.S. companies – Parmalat, Vivendi, Hollinger, Ahold,

Adecco, TV Azteca, Royal Dutch Shell, Seibu, China Aviation, and others –

accused of managerial fraud, accounting irregularities and other governance



Related to these disclosures of alleged gross corporate malfeasance, there

was also a more widespread erosion of standards throughout our markets, with

questionable practices becoming accepted and ethical corners being cut on a

too frequent basis. The net effect has been to undermine the faith investors

have in the integrity of the world’s capital markets. When investors buy

shares in a company or purchase its debt securities, they must have faith

that the company’s financial statements have been prepared using

high-quality accounting standards designed to accurately reflect the

company’s financial condition. If investors don’t have this faith, they will

insist on a risk premium for their investment. The cost of capital will

increase for these companies, with the obviously negative impact on

investment and employment decisions.


As it becomes extremely time-consuming for investors to distinguish the good

from the bad, they will tend to invest in other markets or perhaps not

invest at all. This is of particular concern in the U.S., at a time when

more than half of all our households have some equity ownership, and

investment decisions on the deployment of retirement funds are increasingly

being delegated to individual beneficiaries. It must also be of concern for

investors, businesses, and regulators throughout the world.


Different countries have responded differently to the problems in the

world’s securities markets, but what’s significant is that there has been a

global recognition of the need for reforms. This is critical, because simply

fixing problems in only one market can result in their reappearance in other

markets. Through multilateral cooperation we can not just learn from each

other, but also raise standards throughout our markets, and ensure that

investors everywhere have the protections they need and deserve.


The Sarbanes-Oxley Act

The American response to the problems I’ve just outlined came in 2002, when

the U.S. Congress and President Bush enacted the law which became known as

Sarbanes-Oxley. The Act is the most significant piece of securities

legislation passed since the securities acts of 1933 and ‘34, the latter of

which created the Securities and Exchange Commission itself. Sarbanes-Oxley

created a new Public Company Accounting Oversight Board to oversee the audit

profession. It created new rules to protect auditor independence and address

conflicts of interest faced by securities analysts. It increased the

penalties for financial fraud and gave the SEC additional resources. The act

also instituted other important safeguards, such as requiring issuer CEOs

and CFOs to certify the company’s financial statements, and mandating that

auditors certify the adequacy of the issuer’s internal controls.


Now, two-and-a-half years later, some critics claim the Sarbanes-Oxley Act

goes too far. In particular, these critics charge that requiring

certification of internal controls — the so-called Section 404 provision of

Sarbanes-Oxley — is too expensive and unnecessary. Section 404 has even led

some foreign issuers to declare that they may wish to leave America’s

capital markets altogether rather than have their internal controls



It is easy for an individual issuer to look at the cost of compliance with

U.S. federal securities laws and balk. But the cost of capital also comes

with benefits. U.S. capital markets are deep and liquid. Nearly half of all

the world’s equity shares, by market capitalization, trade in the United

States. And non-U.S. investors have approximately $4.5 trillion invested in

U.S. stock markets.


Since the 1930s, the U.S. has required some of the most extensive financial

disclosures, backed up by one of the most robust enforcement regimes of any

jurisdiction in the world. As a result, the average person in the United

States who saves even a little money doesn’t feel that the only realistic

investment opportunity is a government-insured savings account. Educated

investors recognize that investing in the stock market entails risk, but the

U.S. government has worked to ensure there is a range of investor

protections and a level playing field. These laws, regulations, and

enforcement activities make the U.S. capital markets attractive to foreign



A First-Class Market

The requirements of Sarbanes-Oxley cannot be evaluated in a vacuum. They are

important because they have produced, and will produce, improvements that

help to restore and reinforce investor confidence in our markets, and lower

the cost of capital to issuers. Section 404, for example, reaffirms that

U.S. legislators are serious about internal control requirements. It is

already clear that Section 404 is helping to strengthen the business

operations of those U.S. and foreign issuers who have seized the opportunity

to use the internal controls assessment as a managerial opportunity and not

simply a compliance exercise.


The disclosures that have been, and will be, made under Section 404 involve

facts that investors should know about a company when making an investment

decision. But these are also facts that management and the board of

directors should know about the companies for which they have



This discussion of Section 404 is a reminder of the need for high standards

in securities markets throughout the world. The overwhelming majority of

investors – regardless of their nationality and regardless of where they’re

investing – demand honesty and integrity. They demand that boards of

directors take their fiduciary duties seriously. They demand that companies

have the internal controls they need in order to ensure the accuracy of

their financial disclosures. And when there is fraud or where securities

laws or regulations are violated, investors rightly expect regulatory

authorities to aggressively pursue enforcement action.


All capital markets talk of honesty and integrity. Full, accurate, and

timely disclosure of material information is a “core principle” of IOSCO.

Strong fiduciary obligations for corporate managers and directors are now

enshrined within the OECD’s Principles for Corporate Governance.


These measures are helping to raise standards throughout the world, but I

still believe there are distinct benefits to listing on a U.S. exchange and

registering with the Commission. I’d like to explain why by drawing a

parallel to the U.S. Marine Corps, which shares some characteristics with

the Royal Marines here in Great Britain. Of all the U.S. armed services, the

Marine Corps has the longest and most intensive basic training for both its

officers and enlisted personnel. The Corps is upfront about its grueling

physical and mental drill. But it has no problem meeting its recruitment

goals. The reason is simple: the Marines are an elite – the best of the



That is what we want the U.S. market to represent as well. We want listing

and registration in the United States, with its extensive requirements, to

signal that the issuer is committed to the highest standards. We also seek

to have a listing in the U.S. signify to investors throughout the world that

this company is willing to make the investment needed to meet these

standards. Companies who choose not to come to the United States may meet

those same standards – but our registrants have taken the extra step of

telling the world that they are up to the challenges that accompany a U.S.



It is entirely consistent with the principles underpinning Sarbanes-Oxley

reforms to also evaluate whether the rules and regulations we write to

implement these principles are effective and appropriate. Have rules been

implemented the right way? What are the relative costs and benefits? Are

there certain situations in which rules should not apply? Or where old rules

have been outmoded or are in need of revision? For instance, we have

recently proposed reforms to the rules governing the “quiet period” in the

weeks preceding initial public offerings, reflecting the advances made in

modern communications methods, such as the Internet. There are many other

areas where we have acknowledged the need for updating and modifying rules,

and there are also examples related to non-U.S. issuers.


Going Forward

In this same vein, the SEC has worked from its earliest days to accommodate

foreign issuers, and to facilitate their access to our markets. In 1935,

just one year after the SEC’s creation, the Commission issued a rule

exempting foreign companies from our rules governing both proxy statements

and reports by insiders of transactions in their company’s securities. More

recently, many issuers have raised excellent points and real concerns about

how Sarbanes-Oxley will be implemented in practice, and how this

implementation may affect those who are listed in more than one jurisdiction

and who operate under more than one set of rules.


The SEC remains committed to a level playing field for all its issuers,

foreign and domestic alike. But we recognize that cross-border listings

frequently entail issuers having to navigate duplicative or even

contradictory regulations in different jurisdictions. While the SEC is

unwilling to compromise where investor protections are concerned, some

duplicative or contradictory regulations can compromise those protections

and place an unnecessary burden on issuers, firms and investors.


I want to emphasize that the SEC is determined to avoid such situations,

where possible. We have demonstrated our willingness to work with foreign

regulators and market participants to reduce the likelihood of this

occurring and continuing uncorrected. One recent example is the SEC’s rule

regarding the composition of audit committees of listed issuers.

Sarbanes-Oxley required the SEC to pass a rule mandating that all members of

audit committees be independent directors. But the corporate governance laws

and regulations in Germany for instance, and a few other countries with dual

board systems, require corporate audit committees to include a labor

representative. SEC rules do not, however, consider employees of an issuer

“independent” for fear that an unscrupulous corporate officer could appoint

employees to the board who were beholden to the company’s management.


Following a dialogue with the European Union and others, the SEC was

reassured that in those jurisdictions with dual boards, the mandatory labor

representatives on issuer audit committees were firmly independent of the

company’s management. The resulting final rule relating to audit committees

contained an exception for these jurisdictions that would allow employees

who are not officers of a company to sit on the audit committee. This

enables the affected issuers to comply with both sets of law. And it

preserves the intent of Sarbanes-Oxley – to ensure that independent

directors can communicate directly with auditors without management



Another example of the SEC seeking to accommodate the special circumstances

of foreign issuers came with our rules related to the publication of

financial information presented in ways not strictly in compliance with U.S.

Generally Accepted Accounting Principles, or GAAP. In this area, we included

an exemption for non-GAAP communications outside the U.S., even where those

communications reach the U.S. We took this action because we did not want to

interfere with the regular practices governing how foreign companies

communicated with investors in non-U.S. markets.


A third example of accommodation is our work with the new Public Company

Accounting Oversight Board to iron out some issues regarding oversight of

foreign audit firms. Under the Sarbanes-Oxley Act, all audit firms,

including non-US audit firms, providing significant audit services for

issuers listed in the United States, are required to be registered and

inspected by the PCAOB. Because of potential conflicts with foreign privacy

laws and blocking statutes, the PCAOB has made some adjustments in the

information requested of foreign firms during the registration process. In

addition, the PCAOB is seeking a collaborative approach to developing its

oversight role vis-à-vis non-U.S. audit firms, working with counterparts in

Europe and elsewhere.


We welcome continued input from the foreign issuer community as well as from

our regulatory counterparts in other jurisdictions. In the short term, I

expect several initiatives that should ease some of the concerns that

foreign private issuers may have about the reforms now being implemented in

U.S. markets.


First, I expect the SEC to consider whether there should be a new approach

to the deregistration process for foreign private issuers if they do not

feel prepared to meet the U.S. requirements. U.S. federal securities laws

and regulations on this issue were designed many years ago, before there was

much in the way of cross-border listings. While the rules were designed to

protect investors, we should seek a solution that will preserve investor

protections without inappropriately designing the U.S. capital market as one

with no exit. We recognize that issuer circumstances change, and that

foreign private issuers should have the flexibility to respond to these



Second, the Commission also recognizes the seismic change that conversion to

IFRS represents for many European countries. We appreciate the European

Union’s efforts in this area because we value the EU’s willingness to

require the use of a single set of high quality accounting standards. This

approach enhances investor understanding. We also understand that conversion

to IFRS, while undoubtedly beneficial in the long run, could be difficult

and expensive for some to implement in the immediate term. Consequently, the

Commission has proposed amendments to our reporting requirements that would

facilitate foreign private issuers’ conversion to IFRS. For those foreign

issuers also listed on U.S. exchanges, the SEC has long allowed these

companies to use IFRS, provided the financial figures were reconciled to

U.S. Generally Accepted Accounting Principles over a three-year period.

Within the next few months, I fully expect the Commission will consider

adopting a proposal to allow first-time users of IFRS to reconcile their

financial statements to U.S. GAAP for only two years, and I am of the firm

view that this would be a step in the right direction.


Third, the SEC recently extended the deadline for smaller accelerated filers

– issuers in the United States with market capitalization between 75 and

$700 million – to come into compliance with SEC rules implementing Section

404 of Sarbanes-Oxley. We pursued this course of action because we

understand there are limited resources available to comply with these

internal control requirements, which may be disproportionately expensive for

companies with fewer resources to devote to compliance and their internal



Though the Sarbanes-Oxley Act does not provide an exemption for foreign

private issuers, we will continue to be sensitive to the need to accommodate

unique foreign structures and requirements. Many non-U.S. companies and

their auditors are well on their way to completing the processes necessary

to report on internal controls. Of all the reforms contained in the Act,

getting these processes right is likely to have the greatest long-term

impact on enhancing the reliability of financial reporting. However, many

companies outside the U.S., especially in Europe, face additional challenges

in the near term that go above and beyond those faced by U.S. companies as

European companies adopt international financial reporting standards for the

first time in 2005.


To address these burdens, I have asked the staff of the Commission to

consider whether to recommend that we delay the effective date of the

internal control on financial reporting requirements for non-U.S. companies.

We will continue to monitor progress in these areas and we are prepared to

reach out and engage in an open dialogue to address concerns regarding

reporting on internal controls.



There are, of course, many other important issues looming on the

international landscape, but the fundamental issue for everyone involved in

financial markets today, regardless of company or country, must be to

maintain high standards – legal, regulatory, and ethical – that breed trust

and confidence. This becomes increasingly important at a time when money

managers can move capital around the globe with a few clicks on a computer.

Capital will flee environments that are unstable or unpredictable – whether

that’s a function of lax corporate governance, ineffective accounting

standards, a lack of transparency, or a weak enforcement regime. Investors

must see for themselves that companies are living up to their obligations

and embracing the spirit underpinning all securities laws. Only then will

the place of the world’s securities markets as an engine of prosperity be

assured – in America, in Europe, and throughout the world.


Thank you.



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