On December 21, 2007 in its latest important step toward international convergence the United States Securities and Exchange Commission (“SEC”) decided to permit foreign private issuers to submit to the SEC the same financial statements, prepared in accordance with International Financial Reporting Standards (“IFRS”) as published by the International Accounting Standards Board (“IASB”) that they file in their home countries.[1]^, [2] Additional initiatives are under consideration by the SEC and its staff. See discussion below.

The amendments will be applicable to annual financial statements for financial years ending after November 15, 2007, and to interim periods within those years, that are contained in filings made after the effective date of the amendments.

Eligibility and Implementation

The amendments will apply only to “foreign private issuers” that file on Form 20-F, regardless of whether the issuer complies with IFRS as issued by the IASB voluntarily or in accordance with the requirements of the issuer’s home country regulator or exchange on which its securities are listed.  Form 20-F serves as the combined registration statement and annual report for foreign private issuers under the Exchange Act, and also sets forth the disclosure requirements for registration statements filed by foreign private issuers under the Securities Act.  The basic financial statement requirements for foreign private issuers are described in Items 17 and 18 of Form 20-F. 

In implementing its decision to accept IFRS statements without GAAP reconciliation, the SEC has amended Items 17 and 18 of Form 20-F and Regulation S-X to accept financial statements of foreign private issuers that are prepared on the basis of the English Language Version of the IFRS as published by the IASB without reconciliation to U.S. GAAP.[3]  Conforming amendments to Rules 1-02, 3-10 and 4-01 of Regulation S-X, Securities Act Forms F-4, S-4 and Securities Act Rule 701 have also been made. 

Foreign private issuers taking advantage of this option must state explicitly and unreservedly in the notes to their financial statements that such financial statements are in compliance with IFRS as issued by the IASB and provide an unqualified auditor’s report that opines on that compliance. 

The auditor’s report can include this language in addition to any opinion relating to compliance with standards required by the home country.  

Relief from reconciliation also extends to required interim reports. Eligible foreign private issuers will be able to omit the U.S. GAAP reconciliation from their un-audited financial statements relating to interim periods only if the audited annual financial statements included or incorporated by reference for all required periods are prepared in accordance with IFRS as issued by the IASB.  If not so prepared, then in order to be able to omit the U.S. GAAP reconciliation from required interim period financial statements, an issuer would amend prior filings in order to appropriately revise the audited financial statements. 

In addition, interim reports will not require disclosure under Article 10 of Regulation S-X, in each instance, if the interim financial statements fully comply with IAS 34.[4]  The SEC has also extended, indefinitely, the two-year accommodation contained in General Instruction G of Form 20-F to all first time adopters of IFRS as issued by the IASB. 

Existing reconciliation requirements are not changed for foreign private issuers that file their financial statements under other sets of accounting standards or that are not in full compliance with IFRS as issued by the IASB. A foreign private issuer will continue to be required to provide a reconciliation to U.S. GAAP under these amendments if:

·      its financial statements include deviations from IFRS as issued by the IASB;

·      it does not state unreservedly and explicitly that its financial statements are in compliance with IFRS as issued by the IASB;

·      the auditor does not opine in compliance with IFRS as issued by the IASB; or

·      if the auditors report contains any qualifications relating to compliance with IFRS as issued by the IASB. 

A foreign private issuer using a jurisdictional or other variation of IFRS will be able to rely on the amendments if that issuer also is able to state compliance with both IFRS as issued by the IASB and a jurisdictional variation of IFRS “and does so state”, and its auditor opines that the financial statements comply with both IFRS as issued by the IASB and the jurisdictional variation, as long as the statement relating to the former is unreserved and explicit. 

Issuers listed in the EU are required to prepare their statutory financial statements using IFRS as adopted by the EU.  The SEC noted in the Adopting Release that presently, the only difference between IFRS as issued by the IASB and IFRS as adopted by the EU relates to IAS 39, “financial instruments; recognition and measurement,” whereby IFRS, as adopted by the EU, offers greater flexibility with respect to hedge accounting for certain financial instruments than does IFRS as issued by the IASB.  As a practical matter, this difference applies only to foreign financial institutions, several of which commented to the SEC that they do not avail themselves of the approach afforded by the EU-endorsed standard and that, therefore, they will be able to assert compliance with both IFRS as endorsed by the EU and IFRS as issued by the IASB. 

The SEC will accept from existing SEC registrants from the EU that have already utilized the EU’s IAS 39 carve out[5] in financial statements previously filed with the SEC, financial statements that do not include a reconciliation to U.S. GAAP, if those financial statements otherwise comply with the IFRS as issued by the IASB and contain a reconciliation to IFRS as issued by the IASB.  This reconciliation to IFRS as issued by the IASB is to contain information relating to financial statement line items and footnote disclosure based on full compliance with IFRS as issued by the IASB.  The reconciliation is to be prepared and disclosed in the same manner that foreign private issuers presently provide reconciliation of their financial statements to U.S. GAAP under Item 17 and Item 18 of form 20-F.  The transition relief is for only their first two financial years that end after November 15, 2007.

All financial statements of foreign private issuers that use the IAS 39 carve out for periods prior to the financial year that ends after November 15, 2007, must continue to be reconciled to U.S. GAAP.  At the end of the transition period these registrants will have the same financial statement reporting choices as that of any foreign private issuer (e.g., if they continue to use the IAS 39 carve out they will remain subject to the U.S. GAAP reconciliation requirements of Item 17 and Item 18).  Amendments adopted to Items 17 and 18 of Form 20-F accommodate this transition provision.

Effective Date

The amendment is effective March 4, 2008, and until effective, companies are subject to the existing rules regarding the inclusion of U.S. GAAP information. Some foreign private issuers with a fiscal year ending after November 15, 2007 may wish to file their annual report on Form 20-F prior to March 4, 2008 using financial statements prepared in accordance with IFRS as issued by the IASB and exclude the U.S. GAAP reconciliation. John White, the Director of the Division Corporation Finance at the SEC has encouraged issuers in this situation to contact the Division of Corporation Finance's Office of Chief Accountant to discuss your facts and circumstances. Any accommodation or waiver request must be made in writing.

Form 20-F

Form 20-F is available to foreign private issuers (other than asset-backed issuers) to use as a registration statement under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”).  It is also the form on which a foreign private issuer must file its annual report, which is due within 6 months after the end of the fiscal year covered by the report.  Under Item 17(c), a foreign private issuer must either prepare its financial statements and schedules in accordance with U.S. GAAP or, if the financial statements and schedules are prepared using another basis of accounting, include a reconciliation to U.S. GAAP as described under item 17(c)(2).  This reconciliation includes a narrative discussion of reconciling differences, a reconciliation of net income for each year and any interim periods presented, a reconciliation of major balancing captions for each year and any interim periods, and a reconciliation of cash flows for each year and any interim period.  The amendments to items 17(c) provide that a reconciliation will no longer be required from foreign private issuers that prepare financial statements that comply with IFRS as issued by the IASB. 

Under Item 18 of Form 20-F a reconciliation to U.S. GAAP requires that an issuer provide all information required by U.S. GAAP and Regulation S-X, in addition to the reconciling information for line items specified in Item 17(c).  Item 18(b) has also been revised to indicate that U.S. GAAP and Regulation S-X disclosures will not be required if the issuer files financial statements using IFRS as issued by IASB.

Interim Financial Statements

A foreign private issuer that is eligible to omit a U.S. GAAP reconciliation from its audited annual financial statement also will be able to omit a reconciliation from its un-audited interim financial statements which, to the extent such financial statements are required will also have to be prepared in accordance with IFRS as issued by the IASB. 

In registration statements and prospectuses under the Securities Act and initial registration statements under the Exchange Act, if the document is dated less than nine 9 months after the end of the last audited financial year, foreign private issuers are not required to include interim, financial information and.  If, however, a foreign private issuer has published interim financial information, Item 8.A.5 of Form 20-F requires these registration statements and prospectuses to include that information and describe any material variations between the accounting principles used and U.S. GAAP and quantify any material variations that have not been quantified in the annual financial statements.  A new instruction has been added to Item 8.A.5 of Form 20-F to clarify that interim period financial information that is made public by a foreign private issuer need not be reconciled to U.S. GAAP if the basis of accounting used in the annual financial statements and the published interim information is IFRS as issued by the IASB. 

In registration statements and prospectuses under the Securities Act and initial registration statements under the Exchange Act,  if the document is dated more than nine months after the end of the last audited financial year, foreign private issuers must provide consolidated interim financial statements covering at least the first six months of the financial year and the comparative period for the prior financial year.  These un-audited financial statements must be prepared using the same basis of accounting as the audited financial statements contained or incorporated by reference in the document and include or incorporate by reference the reconciliation to U.S. GAAP.  Under the rules a foreign private issuer that relies on the new instruction to provide IFRS financial statements for an interim period without reconciliation to U.S. GAAP will not be required to comply with Article 10 of Regulation of S-X for interim period financial statements provided pursuant to Item 8.A.5 of Form 20-F, if it complies with and explicitly states compliance with IAS 34. 

Selected Financial Data. 

Under Item 3.A. of Form 20-F, issuers must provide five years of selected financial data.  The SEC amended Item 3.A. of Form 20-F to clarify that selected financial data based on U.S. GAAP reconciliation is required only if the issuer prepares its primary financial statements using a basis of accounting other than IFRS as issued by the IASB. 

Other Form 20-F Disclosure

Reference to U.S. GAAP Pronouncements in Form 20-F.  The SEC adopted instructions to Item 5 and Item 11 to indicate that issuers preparing their financial statements in accordance with IFRS as issued by the IASB should provide in responding to paragraphs of those items that refer to specific pronouncements of U.S. GAAP, disclosure that satisfies the objective of the items disclosure requirements.  If information called for by the non-financial statement requirements of Form 20-F duplicates information that is contained in the IFRS financial statements, an issuer need not repeat such information but may cross reference to the appropriate footnote in the audited financial statements.

Disclosure by Oil and Gas Companies.  Item 19 of Form 20-F was amended to expressly require that any issuer that provides disclosure under FAS 69, “disclosures about Oil and Gas producing activities”, continue to provide that disclosure even if the issuer is preparing financial statements in accordance with IFRS as issued by IASB without a reconciliation to U.S. GAAP.

Market Risk Disclosure and Safe Harbor Provisions.  The safe harbor provisions for forward looking statements provided under Section 27A of the Securities Act and Section 21E of the Exchange Act expressly exclude any information “included in a financial statement prepared in accordance with generally accepted accounting principles”. 

Forward looking market risk disclosure required by IFRS 7, “financial instrument; disclosure,” appears in footnotes to audited IFR Financial statements and will not be covered by the safe harbor provisions.  On the other hand, market risk disclosure provided pursuant to Item 11 of Form 20-F is not included as part of the financial statement in a filing and is expressly subject to the safe harbor provision.  This is an issue that exists currently even with a U.S. GAAP reconciliation, and therefore is distinct from the SEC’s acceptance of IFRS financial statements without a U.S. GAAP reconciliation and affects foreign private issuers generally.

Areas Where IFRS Guidance Does Not Exist or Permits Different Options

In areas for which an IFRS does not exist, IAS 8 requires preparers to use judgment in developing accounting policies such that financial information is provided that, among other things, as relevant to the needs of users and the financial statements reliably reflect the economic substance of transactions.[6]  Preparers must consider other guidance found in IFRS and, if no analogous guidance is found, the definitions, criteria and concepts in the IFRS concept ional framework.  IAS 8 allows preparers to consider pronouncements of other standard-setting bodies to the extent that such guidance does not conflict with the concept underlying IFRS.  In areas that are not addressed by IFRS, consistent with IAS 1 and IAS 8, companies may provide full and transparent disclosure in the financial statements and operating and financial review and prospects disclosure about the accounting policy selected and the effects of those policies on the IFRS Financial Statements.

SEC Guidance and Regulation S-X Still Apply

The SEC noted that even though a company may no longer be required to reconcile an IFRS statements to U.S. GAAP it must continue to follow any SEC guidance that relates to auditing issues such as is found in Accounting Series Releases, Financial Reporting Releases and Staff Accounting Bulletins.  Financial Reporting Releases contain the SEC’s views and interpretations relating to financial reporting.  Staff Accounting Bulletins reflect the SEC staff’s views regarding accounting-related disclosure practices.  They represent interpretations and policies followed by the Division of Corporation Finance in the office of the Chief Accountant in administering the disclosure requirements of federal securities laws.  Industry guides serve as expressions of the policies and practices of the division of corporation finance.  They are of assistance to issuers, there counsel and others preparing registration statements and reports, as well as to the SEC’s staff.  Staff Accounting Bulletins and industry guides are not rules, regulations, or statements of the SEC.  The SEC has not approved nor disapproved the interpretation.  Regulation S-X contains the form and content requirements for financial statements included in filings made with the SEC.  It also includes provisions that do not relate to U.S. GAAP.  Regulation S-X will continue to apply to the filings of all foreign private issuers, including those who file financial statements prepared using IFRS as issued by IASB without reconciliation to U.S. GAAP. 

Conforming amendments have been made to the Securities Act Form F-4 and S-4.     Form F-4 is the registration statement for the securities of foreign private issuers and certain business combinations, and Form S-4 is a registration statement for securities with domestic issuers issued in business combinations. 

Rule 701

Rule 701 under the Securities Act provides an exemption for registration for offers sales made under certain compensatory benefit plans.  The exemption is not available to issuers that have a reporting obligation under the Exchange Act and does not involve the filing of any information with the SEC.  An issuer conducting an offering under Rule 701 must deliver to investors certain information, including financial statements, if more than $5 Million in securities are sold over a twelve month period.  For foreign private issuers, financial statements provided under Rule 701 must include a reconciliation under Item 17 of Form 20-F if they are not prepared in accordance with U.S. GAAP.  Rule 701 has been amended to clarify that a foreign private issuer that conducts an offering under Rule 701 and prepares its financial statements using IFRS as issued by the IASB should not be required to present a U.S. GAAP reconciliation.

Small Business Issuers

A Canadian foreign private issuer that qualifies as a small business issuer under Regulation S-B may elect to provide the disclosure in its registration statements and annual reports, in compliance with the forms based on Regulation S-B rather than on Form 20-F.[7]  If a foreign private issuer chooses to file a registration statement or annual report on a domestic form based on Regulation S-K, financial statements prepared using U.S. GAAP would be required.  Regulation S-B describes the financial statement requirements for a small business issuer, which must be prepared in accordance with U.S. GAAP or, if filed by a foreign private issuer that also is a small business issuer, reconciled to U.S. GAAP in accordance with requirements of Items 17 or 18 of Form 20-F, as appropriate.

Disclosure requirements for smaller companies previously contained in Regulation S-B have been integrated into Regulation S-K and smaller reporting companies that file annual reports on Form 20-F or Securities Act registration statement based on Form 20-F will be able to file financial statements prepared using U.S. GAAP, IFRS as issued by the IASB without a U.S. GAAP  reconciliation, or another comprehensive basis of accounting with a U.S. GAAP reconciliation. 

Form 1-A Regulation A

The SEC has decided, for the time being, not to revise Form 1-A under Regulation A as it appears that Canadian issuers filing on that form would not be able to avail themselves of the adopted amendments until Canadian accounting standards setters permit the use of IFRS.[8] 

MJDS

Certain Canadian foreign private issuers file registration statements and annual reports under the multi-jurisdictional disclosure system (“MJDS”), which permits eligible Canadian companies to use their disclosure documents prepared in accordance with Canadian requirements and filings with the SEC.  Certain filings under the MJDS are not required to contain a reconciliation to U.S. GAAP.  A U.S. GAAP reconciliation is required in registration statements and annual reports on Form 40-F and registration statements on Form F-10, each when used for common equity securities, securities convertible into common equity securities and other securities not rated an investment grade.  Canadian issuers that participate in the MJDS generally use either Canadian GAAP, with a U.S. GAAP reconciliation when required, or U.S. GAAP in their filings with the SEC.   The SEC did not adopt revisions to the MJDS forms.  Forms 40-F and F-10 contain a cross reference to the U.S. GAAP reconciliation requirement under Items 17 and 18 of Form 20-F.

Cooperation Among Authorities for Capital Market Regulation

The decision to accept IFRS financial statements without reconciliation to U.S. GAAP in SEC filings was crafted to support the efforts of the IASB and many other nations, to establish IFRS as a single, global set of standards. 

The SEC noted in the Adopting Release that the adoption IFRS throughout the European Union in 2005, and similar decisions by Australia, Hong Kong and South Africa, led the way in a process that has since resulted in over a hundred countries requiring or permitting the use of IFRS. India and Korea will each adopt IFRS by 2011.  In Brazil, listed companies will have to comply with IFRS beginning with 2010.  Convergence between Japan GAAP and IFRS are expected by 2011.  China has introduced a new set of accounting standards intended to produce similar results as IFRS. 

The SEC has joined other authorities responsible for capital market regulation – the European Commission, the Financial Services Agency of Japan and the International Organization of Securities Commissions (“IOSCO”) to work together to achieve the means of greater accountability for the IASB and the IASC Foundation to those governmental authorities charged with protecting investors and regulating capital markets. 

The SEC has made this decision despite, acknowledging that there are still a number of differences between U.S. GAAP and IFRS as issued by the IASB, and that there remains specific accounting subjects that the IFRS has yet to address fully. 

The staff at the Division of Corporation Finance has published its observations on the review of IFRS financial statements included in the annual reports of more than 100 foreign private issuers.[9]  

Auditors, generally commented to the SEC that they have sufficient experience and familiarity with IFRS to be able to opine on IFRS financial statements, and that the elimination of the U.S. GAAP reconciliation would provide an incentive to develop IFRS capabilities faster than if U.S. GAAP reconciliation where retained. 

The SEC has noted that a cooperative infrastructure has been put in place by regulators to identify and avoid inconsistent or inaccurate applications of IFRS globally so as to foster the consistent and faithful application of IFRS around the world.  The infrastructure includes IOSCO, in which the SEC participates.  IOSCO has established a database among member regulators for sharing regulators’ decisions on the application of IFRS a work plan has been established between the SEC and the Committee of European Securities Regulators to consult with one another with the goal of avoiding conflicting conclusions regarding the application and enforcement of IFRS.

 

Additional SEC Initiatives To Facilitate Access to Capital By Foreign Private  Issuers

A number of initiatives aimed at foreign private issuers were effected in 2007 and John White, the Director,  has stated that a leading theme for the Division of Corporation Finance of the SEC  in 2008 is international matters.  We review below, the initiatives that were effected in 2007  and those under consideration.

Deregistration. In  March 21,2007 the SEC approved new final rules that significantly changed the requirements regarding when and how foreign private issuers can exit the Exchange Act reporting system[10]. Unlike the older rules that required a foreign private issuer to have fewer than 300 U.S. holders before it could deregister, new Exchange Act Rule 12h-6 was effective June 4, 2007 and permits a qualifying foreign private issuer (regardless of its size)  to deregister a class of equity securities if the U.S. average daily trading volume of the subject class of securities has been no greater than five percent of the average daily trading volume of that class of securities on a worldwide basis for a recent 12-month period.  The new rule was effective prior to June 30, 2007, to enable calendar year filers who desired to withdraw from U.S. registration prior to first being subject to filing Sarbanes Oxley Act Section 404 reports in Form 20-Fs due on June 30 to do so.

Mr. White has reported that as of the year ended 2007, 100 foreign private issuers had filed Form 15F(not including 25 that had already deregistered under the older exit rules but filed Form 15F to gain the benefits of new Rule 12h-6). This corresponds to just under 9% of all foreign registrants, with the largest group ( 53%) coming from the European Union. As stated by Mr. White,  the “ thinking here is that if you know you can leave when you want to, then it's more attractive to register or stay registered..”   During  2007, more than 75 new foreign private issuers registered securities with the SEC.   

Upcoming International Initiatives. In 2008 Mr. White anticipates that the Division will be turning to several less high profile matters relating to foreign private issuers where they may recommend providing relief and easing requirements for foreign issuers in some areas, while establishing new requirements in others.  Mr. White believes that consideration should be given to revising Exchange Act Section 12(g) "entrance rules" for foreign private issuers, particularly in light of the new deregistration rules; the use of automatic shelf registrations by foreign companies that are well-known seasoned issuers (WKSIs)[11]; advancing the six-month Form 20-F filing deadline for the foreign issuer annual report; the basic application of the foreign private issuer definition itself[12]; and revisions to the cross-border tender offer rules  with respect to the way U.S. ownership of a subject company's securities is calculated.

 

 

Mutual Recognition In 2008 Mr. White also reports that the staff will be spending a significant amount of time in mutual recognition. Under the mutual recognition arrangements being discussed, foreign brokers and exchanges from selected jurisdictions would be allowed to operate in the U.S. without registration under certain circumstances. The mutual recognition model is premised in large part on a determination that a foreign regulatory regime provides comparable protections and results to those afforded to U.S. investors under U.S. securities laws.  Consideration will be given not just to issues relating to the foreign brokers and exchanges themselves, but also issues relating to the foreign companies whose securities would be tradable through a mutual recognition system.

 

CONCLUSION

The SEC expects that its acceptance of IFRS financial statements without U.S. GAAP reconciliation will encourage more foreign issuers to prepare financial statements in accordance with IFRS.  They also expect that it will facilitate capital formation for foreign private issuers that are registered with the SEC.  In the Adopting Release the SEC stated that reporting by foreign private issuers using a single IFRS platform should help American investors analyze and get more readily comparable information from the U.S.–registered foreign companies in which they invest.

It may have been a long time in coming but it is evident that the SEC has recognized that the U.S. will not be the sole standard setter in every facet of  the globalization of the capital markets.

Lola Miranda Hale,

Epstein Becker & Green P.C.

312 499 1440

 lhale@ebglaw.com