In another step to making the U.S. capital markets more receptive to non-U.S. issuers, the U.S. Securities and Exchange Commission (the “SEC”) has proposed a new rule that would allow foreign private issuers to use financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”) as published by the International Accounting Standards Board (“IASB”) in their filings with the SEC without the requirement to reconcile those financials statements to generally accepted accounting principles used in the United States (“U.S. GAAP”).1 This would impact what financial statements are required in filing annual reports on Form 20-F, Multijurisdictional Disclosure System filings by Canadian issuers and any registration statement filed by a foreign private issuer. The SEC has also published a concept release to examine whether to permit U.S. issuers to use financial statements under IFRS.
The IFRS is overseen by the IASB, an independent, privately funded organization. Almost 100 countries, including all member states in the European Union (the “EU”), now require or allow the use of IFRS and many other countries are replacing their national standards with IFRS. The EU requires that all companies incorporated in one of its member states whose securities are listed on an EU regulated market report their consolidated financial statements using endorsed IFRS. These requirements affect approximately 7,000 companies in the EU.
The SEC, IASB and the Financial Accounting Standards Board, which sets the standards for U.S. GAAP, have encouraged a process of convergence between U.S. GAAP and IFRS into a single system of global, compatible accounting standards for many years. Although the convergence process is ongoing, the SEC has decided that there is strong support in the legal and accounting communities for eliminating the requirement of reconciling IFRS financial statements to U.S. GAAP.
Currently, the SEC requires U.S. issuers to include with their SEC filings, financial statements prepared in accordance with U.S. GAAP. Foreign private issuers in their SEC filings may either file financial statements that are prepared in accordance with U.S. GAAP or file financial statements which are prepared in accordance with the issuer’s home country GAAP. If an issuer chooses to file non-U.S.
GAAP prepared statements, the issuer is required to submit a reconciliation of its financial statements to U.S. GAAP. In a reconciliation, a foreign private issuer must identify and quantify the material differences between its financial statements and the requirements of U.S. GAAP and SEC rules. The SEC is proposing revisions to the rules under which it would accept financial statements of foreign private issuers prepared in accordance with the English language version of IFRS as published by the IASB without reconciliation to U.S. GAAP. Foreign private issuers will be permitted to comply with the revised requirement whether they are using IFRS voluntarily or as a result of compliance with their domestic rules or local stock exchange requirements. For foreign private issuers that are not required to provide U.S. GAAP reconciliations, those issuers that utilize Item 18 under Form 20-F also will not be required to provide the enhanced footnote disclosure required under Item 18.
Under the proposed rules, a foreign private issuer that prepares its financial statements in accordance with IFRS as published by the IASB will not have to reconcile them with U.S. GAAP. In order to omit the reconciliation, the foreign private issuer would be required to state explicitly in a prominent footnote that its financial statements comply with IFRS as published by the IASB. Additionally, the independent auditor of the financial statements must state in its report that those financial statements comply with IFRS as published by the IASB.
The proposed amendments would not be available to an issuer that files financial statements that include deviations from IFRS as published by the IASB or that files its financial statements using a set of generally accepted accounting principles of another jurisdiction. A foreign private issuer that does not state unreservedly and explicitly that its financial statements are in compliance with IFRS as published by the IASB, or for which the auditor’s report contains any qualification relating to the application of IFRS as published by the IASB, would continue to be required to provide a U.S. GAAP reconciliation. Some commentators have questioned whether many issuers will be able to satisfy the SEC’s standard for IFRS. Under the proposed rules it would be acceptable for a foreign private issuer to comply with both IFRS as published by the IASB and generally accepted accounting principles of another jurisdiction or a jurisdictional or other variation of IFRS– for example, to comply with national regulations which impose variations in accounting standards – so long as the foreign private issuer states unreserved and explicitly that the financial statements comply with IFRS as published by the IASB and an audit firm opines that the financial statements comply with IFRS as published by the IASB. The auditor qualification requirements under the SEC rules will continue to apply.
Additionally, foreign private issuers may continue to submit financial statements prepared with non-U.S. GAAP or non-IFRS with U.S. GAAP reconciliation information under the current rules if they so choose.
Specific Effects of the Proposed Changes
Interim Period Financial Statements
Under the proposal, foreign private issuers that are eligible to omit the U.S. GAAP reconciliation in their audited annual financial statements would likewise be able to omit a reconciliation from their unaudited interim period financial statements. To the extent a foreign private issuer is required to provide interim period financial statements in an SEC filing such as a registration statement, the financial statements would have to be prepared in accordance with IFRS as published by the IASB. The submission of interim financial statements on a Form 6-K will not be affected by these proposed rule changes since no reconciliation to U.S GAAP was previously required.
Even though an eligible issuer may provide IFRS financial statements for an interim period without reconciliation, that issuer would continue to be required to comply with the form and content requirements of Article 10 of Regulation S-X with regard to financial statements rather than IAS 34. For example, IAS 34 permits more condensed financial statements than Article 10.
Financial Statements of Acquired Companies/Proforma Financial Statements
Where financial statements of an entity acquired or to be acquired is required to be filed by the acquiring company (whether it is a U.S. issuer or a foreign private issuer) in a SEC filing, those financial statements may now be filed without a U.S. GAAP reconciliation if the financial statements were prepared under IFRS as published by IASB. Similarly, under Article 11 of Regulation S-X, these acquirers may be required to prepare unaudited pro forma financial statements. Under the proposed amendments, a foreign private issuer using IFRS as published by the IASB would not be required to reconcile its pro forma financial statements to U.S. GAAP.
Compensatory Benefit Plans in Non-Reporting Companies
Currently Rule 701 of the U.S. Securities Act of 1933 provides an exemption from registration for offers and sales made under compensatory benefit plans. However, if more than $5 million in securities are sold by a company over a 12-month period, the company must reconcile its financial statements with U.S. GAAP for purposes of the offering. Under the proposed rules, a foreign private issuer that conducts an offering under Rule 701 and that uses IFRS as published by IASB for its financial statements would not be required to submit a U.S. GAAP reconciliation, even if it sells over $5 million in securities in that 12- month period.
SEC Observations on Areas in which IASB Has Yet to Develop Standards
From the SEC's point of view, there are several areas that are not fully developed under IFRS that will need to be particularly addressed in SEC filings. The release does not provide particular guidance on how to approach these areas and are likely to require further SEC guidance going forward.
- Accounting for Insurance Contracts and Extractive Activities
- Accounting Treatment for Common Control Mergers, Recapitalization Transactions, Reorganizations, Acquisitions of Minority Shares Not Resulting in a Change of Control, and Similar Transactions
- Income Statements and Per Share Amounts**
The proposed rule if adopted will be welcome relief to those foreign private issuers that can produce financial statements using IFRS as published by IASB. These issuers will be likely have lower audit fees as well as be able to eliminate the need to have internal accounting staff conversant in U.S. GAAP. We note that the proposed rules do not change the requirement for foreign private issuers to produce management assessments of internal controls and related auditor's reports under Sarbanes-Oxley Section 404 .
The SEC is soliciting comments until September 24, 2007.