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Don Walker on what’s next in financial regulation

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Modern Money

Don Walker is a senior managing director at FTI Consulting and a former senior assistant chief accountant in the Division of Corporation Finance at the Securities and Exchange Commission. He recently discussed the state of financial regulation.

The Dodd-Frank Act requires regulators to promulgate more than 200 rules. What is the most important Dodd-Frank rule-making process that you are following?

My greatest concern is the Financial Stability Oversight Council oversight of non-bank financial companies. How that designation is determined and what examination/oversight is applied are essential to addressing financial-system weaknesses exhibited in the recent  financial market problems. But, companies may object to being deemed systemically important given the significant extra oversight that entails and may therefore bring pressure to slow or reverse the process for their firm.

The Securities and Exchange Commission is investigating potential conflicts of interest in the market for buying and selling shares of private companies. How will the SEC investigation affect these types of transactions?

Currently, U.S. private companies are not required to register their securities and file audited financial statements with the SEC, so public financial information about those companies is limited. As a result, those investors with indirect access to equity interests are purchasing interests in a similar manner to those investors who purchase mutual funds, and are relying on others for judgment and diligence. The indirect manner of purchase raises the issue of registration and regulation of the entity which has direct ownership of the equity interest.

The entities engaging in these transactions will likely reassess their compliance with the current securities laws, and, to the extent they perceive legal exposure, may limit or redesign their activities. Some participants in those markets have already moved their transactions outside the U.S. and limited their interactions to counterparties not subject to the SEC’s regulation.

Should companies adopt clawback policies and disclose their policies on hedging of equity compensation and pay-for-performance ahead of the SEC’s proposals on corporate governance?

Sarbanes-Oxley already has a clawback requirement applicable to the CEO and CFO in cases where there have been financial-statement restatements. Some companies have redesigned their equity-compensation programs so that equity interests have longer-term vesting or earn-out features. One approach to pending corporate disclosure and governance rules is to await the enactment of the rules before changing policies. Without the details of future rules being enacted, it is difficult to develop compliant disclosures and governance.

When do you expect the SEC will make a decision on whether it should permit or require a switch to International Financial Reporting Standards for U.S. public companies? What do you expect that decision to be?

There are a number of major revisions to accounting standards being addressed by the Financial Accounting Standards Board and International Accounting Standards Board which have a summer 2011 timetable, but SEC Chairman Mary Schapiro recently stated that the commission is not committed to a June 2011 date. Also, the Public Company Accounting Oversight Board has just recently obtained international cooperation in reviewing audits of auditing firms and affiliates. These suggest that the SEC may not be ready to require a switch to IFRS in the immediate future.

That said, the recent discussions of “condorsement” — the process of injecting and endorsing individual joint FASB/IASB standards into U.S. GAAP while working to completely converge existing U.S. GAAP and IFRS standards at some point in the future — suggest that some progress is being made toward that eventual goal.

The perception that IFRS standards are applied differently in the many jurisdictions that permit or require their use complicates U.S. acceptance. In addition, standards-enforcement protocols differ around the world.

Finally, the hurdles that IFRS must clear before the SEC requires adoption are significantly higher than those which might be acceptable to the SEC for permitting U.S. companies to choose to use IFRS. Required adoption might require fundamental changes in the IASB governance structure, and would raise questions about the ongoing role of the FASB. In addition, there would likely be congressional deliberation about the SEC’s delegation of accounting standard-setting power to an international body.

How do you think the Financial Accounting Standards Board and the International Accounting Standards Board will converge on lease accounting rules?

Convergence of lease accounting rules is extremely difficult given the weight of debt covenants which might be violated by bringing former operating leases and their obligations onto the balance sheet. In addition, the redeliberations of proposed FASB pronouncements suggest that FASB has not completed its determinations. The process of convergence of a standard which so changes the balance sheets is complicated by the difficulties shown in the FASB process. FASB and IASB are attempting to work with a joint process; in the matter of lease accounting, which the U.S. has had two previous standards for, it will take a significant amount of time.

What is the one compliance issue companies should pay more attention to?

From an accounting and disclosure point of view, the accounting for and disclosures about business segments have the potential for creating financial-statement restatements in a variety of ways.  Goodwill and other impairment determinations are  driven by segmentation. Profitability of business segments is affected by the propriety of aggregation of operating segments. The segmentation rules themselves seem to assume that a business is governed by a single view of performance, when in fact, companies view performance through a matrix of reporting, which may encompass legal entity, geographical location and product line — setting up a natural tension with regulators that must be resolved.

How will the proposed budget cuts affect Securities and Exchange Commission’s enforcement?

The current situation already affects the morale of the staff. It is hard for those experienced and well-trained lawyers and accountants and analysts to operate with reduced resources in the face of the significant increases in business activity and mandated increases in rule-writing and enforcement. Offices which planned to focus on major financial companies have not yet been staffed. Clearly the effectiveness of the enforcement of the securities laws would suffer under the proposed budget cuts.