Subject: File No. S7-04-00 Author: "Uri Jahran" Date: 02/23/2000 10:03 PM I. Summary: SEC should ~not~ modify its current requirement for all financial statements to be reconciled to US GAAP Bring the IASC standards up to the US GAAP. I do not support IASC Final Interpretations because they allow managers to get away with poor risk mitigation in speculative/profitless bubbles in Asia. Management needs to know that the owner investor can get information related to both the success and failure of management risk mitigation efforts. The current IASC FI rewards speculation. That is not conservative and I support US-GAAP. II. Point: Investors are not served by IASC A. There is a poor track history of audits in IASC-implementing countries; B. Auditors have yet to prove they can conduct a credible audit per GAAS; C. Auditors have poor crediblity using IASC compared to GAAP and GAAS; there are problems tracing Russian Funds to British Islands and NY; and D. There is "less than conservative financial information" from firms operating under IASC III. Creative accounting A. Adequacy of audits B. Disturbing trends in China and Japan (1) Booking debt as revenue (China); (2) Hiding debt in subsidiaries (Japan, China, Korea); and (3) Reporting growth despite falling energy consumption. III. IASC becomes GAAPII I hope IASC does not become GAAP through "Final interpretations." If that's where we're going, stick with GAAP. IV. Dislosure of signifigant influence A. IAS 28 An associate is an enterprise, other than a subsidiary or joint venture, over which the investor has significant influence. Significant influence means the power to participate in financial and operating policy decisions. Such influence is presumed to exist if the investor owns more than 20 per cent of the associate. B. IAS assumes influence at 20%, yet US GAAP and SEC require insider trading notification. C. Concern: IASC overrule the SEC stipulations on "influcence" through and negate the requirement to disclose insider trading. V. Problematic SIC Final Interpretations A. Hidden Debts Poor IASC policy to account for hidden debts in subsidiaries (China, Japan) If IASC were adequate, how can we report growth in China despite falling energy consumption? Ideally, effective IASC should have identified these discrepancies and raised questions. To date, there has been no serious examination of how China can increase output with less energy in 1-2Q99. Both IASC and GAAP would not reconcile accounting discrepancies in barter economies (China, Russia); the issue is whether IASC standards, if applied, would meet GAAP disclosure requirements. Currently, GAAP is more useful for investors to assess management ability, risk mitigation, and asset values. B. Unclear ownership (SIC 9) - Title SIC - 9: Business Combinations - Classification either as Acquisitions or Unitings of Interests Ref: http://www.iasc.org.uk/frame/cen12_1.htm#SIC9 - SIC 9 Excerpt: Even if all three criteria are met, a business combination is only to be classified as a uniting of interests if no acquirer can be identified. - Comment: Why is IASC allowing "acquirers" to go unidentified? This contradicts the intent of "full disclosure" of controlling interests. IASC contracits the spirit of GAAP in disclosing controlling interests in entities. owner investors need to know the impact new acqusitions would have on the ability to steer the company during required restructuring. The current IASC allows companies to continue "hidden agreements" in contravention to US-GAAP. C. Non-disclosure of relevant Government Support (SIC 10) - Title SIC - 10: Government Assistance - No Specific Relation to Operating Activities - Comment: Goverment assistance should be disclosed; it is a vital indicator. In countries that award contracts on a rotation basis of "whose turn is it?"If a company wins a government contract today, it may be less likely to win a contract during the next phase. This is material information for investors to assess which would affect a company's growth potential. D. Management not accountable to disclose poor risk mitigation (SIC 11) - Ref: http://www.iasc.org.uk/frame/cen12_1.htm#SIC11 - Title: SIC - 11: Foreign Exchange - Capitalisation of Losses Resulting from Severe Currency Devaluations - Discussion: Companies should be using effective heding strategies. I disagree with SIC stating that "foreign exchange losses on liabilities that result from the recent acquisition of assets should only be included in the carrying amount of the assets if those liabilities could not have been settled or if it was not practically feasible to hedge the foreign currency exposure before the severe devaluation." What SIC is endorsing is "unhedge foreign speculation" Compaies have a responsiblity to hedge the foreign currency exposure. It is immaterial whether the currency devaluation had an impact. Such an outcome is possible. Companies should be required to disclosure the true impact of unhedged positions--this is an indictor of management ability to adequately employ appropriate risk mitigation. The IAS rewards poor management by allowing them to say, "It was not foreseen." In reality, management did not have a balanced derivative portfolio and that is material information investors should have be able to assess. GAAP has a higher standard; IAS allows management to find a loophole to not give full disclosure to the potential impact of a devalution. E. Inadequate disclosure into hidden losses and spiraling debts in subsidies (SIC 12) - Ref: http://www.iasc.org.uk/frame/cen12_1.htm#SIC12 - Title: SIC - 12: Consolidation - Special Purpose Entities - SIC 12 Summary: SIC-12 states that an enterprise should consolidate a special purpose entity ("SPE") when, in substance, the enterprise controls the SPE. - Comment: There should be no consolidation. Such SIC allows entities to pool interests, debts, and losses. This does not give investors full disclosure into deteriorating entities which would have a material impact on assessments of managements plans (if any) to correct problems. SIC 12 helps codify the pooling of problems and reduce insight into early signs of management inability to generate sustainable margins. F. Inadequate disclosure of unsellable assets (SIC 13) - Ref: http://www.iasc.org.uk/frame/cen12_1.htm#SIC13 - Title SIC - 13: Jointly Controlled Entities - Non-Monetary Contributions by Venturers - Point of concern: "Recognition of gains or losses on contributions of non-monetary assets is appropriate unless: (b) the gain or loss cannot be measured reliably" - Comment: (1) If we can't measure the gain of loss, why are we assuming the asset still has value? I would prefer a conservative GAAP approach and say, "If we can't measure the relative value, then it has no value and should be booked as a total loss." (2) SIC 13 allows for "carrying assets that cannot be sold" as a "non-issue." In practice, the "lack of measurability" is a material indicator for lack of market liquidity and is material in illustrating probability no reasonable forecast that the asset can be sold or given away. (3) SIC 13 would not give investors needed insight into factors bearing on future margins, nor adequately communite managements specific initatives to resolve margin problems. (4) SIC 13 falls short by: - Allowing for continuing to hold worthless assets on the books; - Provides no visibility into management slow rolling needed reforms to reduce excess capacity; and - Has marginal incentives address factors bearing on corporate G&A. VI. Concerns with other associations endorsement A. European Commission Endorsement The SIC Final Interpretations do not conform to the EC guidlines of generating reliable and transparent information for investors to assess managment ability to solve problems, mitigate risks, and scope of illiquid assets. Excerpt from European Commission View of IASC Ref: http://www.iasc.org.uk/frame/cen1_6_2.htm Comparable, transparent and reliable financial information is fundamental for an efficient and integrated capital market. Lack of comparability will discourage cross-border investment because of unceertainty as regards the credibility of financial statements. Given the shortcomings of SIC Final Interpretations, I am unclear why the EC supports the IASC. B. AICPA Following the recent PwC "non-disclosure of ownership in stock they owned" and repeated delays in providing meaningful sanctions to members, I am skeptical of anything the AICPA endorses or is associated with. Ref: http://www.iasc.org.uk/frame/cen1_6_9.htm AICPA only implemented solutions after dislosures by the SEC Blue Ribbon Commission and repeated "holding violations" by PwC. Consequently, AICPA has low credibility as a source of proactively addressing the concerns with SIC Final Interpretations. It would be helpful to know which countries currenltly fall under IASC (if any) VII. GAAS -- No mentioned--Why? A. Basis of assessment: There was no reference to "GAAS" on the SEC webpage http://www.sec.gov/rules/concept/34-42430.htm B. Concern: Will IASC have a similar set of GAAS-like procedures that meet US GAAS and support audits of GAAP accounting? Need thorough discussion on how GAAS fits in with IASC. C. IASC GAAS-related qeustions How much will auditors be responsible for fraud disclosure? (1) GAAS Chapters 6 and 7 outline fraud indicators that impact audit scope; I'm unable to determine whether foreign audits conducted in compliance with IASC would be more or less effective in determining the audit scope to assess financial statement reasonableness. (2) Will auditors be given incentives to providing statements beyond the "standard 3 paragraph"? I'd like to see more discussion of "things will be OK when management pays attention to falling margins, rising debt, and spiraling loans to third parties." Benefit: This would give insight into the risks. Currently, I'm unclear that GAAP or GAAS give incentives for auditors to make disclosures relative to management risks; if IASC simply copies GAAP and GAAS, I'm not clear that the auditors have the incentive to meet investor disclosure requirements. Ref: Recent litigation (Sunbeam, Cendant) and auditor conflict of interst (PwC) Issue: Unclear IASC would mitigate these risks nor provide sanctions for gross auditor oversight. VII. Non-financial information I would like to see use of non-financial information in assessing reasonableness of claims. Ex: Actual energy consumption vs reported output Until investors have access to non-financial information, they'll have no way to assess the reasonableness of the audits in IASC-entities.