Subject: Public comment on International Accounting Standards Date: 02/20/2000 1:38 PM Reply to invitation for comment on International Accounting Standards I am an Czech / American residing in the Czech Republic. I have had experience with IAS, US GAAP and local Czech standards as a practitioner, academic and investor. As a practitioner, I have advised companies on how to reconcile local standards both to IAS and US GAAP. As an academic (www.gaap.cz), I have taught US GAAP and financial analysis at the Prague University of Economics. As an investor (www.investment-zone-online.com), I have been active in the (US) stock market since 1986 and have observed developments on the Czech stock market since 1993. In my opinion, IAS is not (yet) rigorous enough to be considered a substitute for US GAAP. I have arrived at this opinion in two ways. First, I have had to reconcile local accounting standards (which are required by law) to both IAS and US GAAP. During these reconciliations, I have found that IAS is so flexible that it allows many (if not most) of the inadequacies of local standards to go uncorrected. Note: in all fairness, IAS has made, over the past few years, significant progress toward becoming more GAAP-like. It is, however, not, in its current form, there yet. US GAAP, on the other hand, is much more specific in its requirements and thus requires adjustments that result in a much more faithful picture of a company's financial position and results. Therefore, allowing international companies that must (by law) use their local standards to reconcile to IAS instead of US GAAP will significantly reduce the quality of the information they provide the investing public. Note: all the accounting professionals I know would, if they had the opportunity, jump at the chance of reconciling to IAS instead of US GAAP. The reason is that, in practice, one can get away with so much in IAS that it makes the reconciliation practically painless and effort free (which is the exact opposite of a US GAAP reconciliation). Second, as an investor, when I originally came to the Czech Republic, I found that its accounting standards were inadequate for supporting rational and informed investment decisions. On realizing this, I began a study of IAS to see (since more local companies reconcile to IAS than to US GAAP) if it were an adequate substitute. After taking the time to examine IAS in detail, I found that it did not force companies to correct many serious inadequacies that exist in their local accounting standards. Thus, while IAS may be applied in a way that can support rational investment decisions, it can also be applied in a way that makes published financial statements practically meaningless (and, from the statements themselves, if is often impossible to tell which is the case). Consequently, I have limited my investments to those companies that list in the US and thus are required to use US GAAP rules. If these companies were allowed to switch to IAS (in its current form), I would, without hesitation, divest my holdings and switch to companies that are GAAP. Infrastructure / oversight As to the question of a sound legal infrastructure and credible oversight. The experience I have had with legislated accounting standards and continental Europe's legal systems force me to draw the conclusion that the legal / regulatory framework in continental Europe is not adequate to support US style "voluntary" accounting standards. There are several reasons for this. The various laws on financial accounting are generally drafted to protect the interests each country's internal revenue service. Investor protection is either absent or an afterthought. The accounting professionals, in countries with these legislated standards, are generally required to adhere to the "letter of the law." Thus, while lip service is paid to the GAAP concept of full disclosure, in practice it is the "letter of the law" that dictates both the application of accounting rules by companies and the audit of the results by independent auditors. The absence of an American style jury system (and thus the absence of the threat of American sized jury awards) significantly reduces auditors' incentive (since they are, in effect, shielded from liability by the "letter of the law.") to strictly apply the more flexible aspects of the various laws on accounting. The absence of an American style jury system also shifts the final burden of ensuring accounting transparency from the civil courts to criminal courts and regulatory agencies (agencies that, in countries such as the Czech Republic, lack the necessary resources and independence to be able to adequately shoulder this burden). The absence of an American style jury system also makes a US style system of allowing the profession to draft accounting rules unworkable. Since the profession's members do not face the prospect of multi-million dollar jury awards, the profession, as a whole, does not have the incentive to draft "bullet proof" accounting standards, in the same way the US profession does. Thus, if IAS is adopted as a US GAAP alternative, the burden of enforcing international accounting transparence will fall on US (or UK) juries (further backing up an already clogged court system). A double standard Allowing a double standard, allowing international companies to use a more flexible system than US GAAP, will put US companies at a competitive disadvantage. This will likely have to two results. First, US companies will, for the first time in history, have significant incentive to abandon the US and move their operations overseas (to take advantage of IAS flexibility). While they are there, it is not unreasonable to expect them to also list on foreign exchanges. Thus, since many of these companies have large followings of loyal shareholders, their doing so will only serve to give more credibility to international capital markets and so undermine the US's main international competitive advantage: its capital markets. Also, if the US accepts IAS, it will give credibility to IAS (since many shareholders, especially individuals, do not understand, appreciate or care about accounting nuances) and so will make international markets acceptable to those investors who have, up to now, stuck with ADRs. This will not only further undermine US capital markets, but will also reduce the incentive of international companies to support improvements in IAS. Further, if US companies are held to a double standard, they will protest. First, these protests will take the form of trying persuade the SEC to not change the rules. Next, if they are not successful, they will take the form of passive resistance. In other words, US companies will start to put significant pressure on their auditors to water down their application of the harsher US GAAP rules and auditors, who are always susceptible to this kind of pressure (especially if it comes at them from all sides), will comply. This will result in a general deterioration of the quality of financial reporting and again will undermine US markets. In conclusion Allowing IAS to become a US GAAP alternative (before it is as rigorous as US GAAP), will undermine the quality of US reporting standards and the prestige of its capital markets. It will also remove the incentive for international companies to try to reach the US's level of transparence and so, in the end, will not only harm US shareholders, but will harm shareholders the whole world over. One final comment I believe the world needs a truly international accounting system. Unfortunately, IAS (in its current form) is, plain and simple, just not good enough. Thus, instead of compromising its standards, the SEC should (especially after all the good it has done in the past few years) redouble its efforts to make IAS a true US GAAP alternative, instead of allowing, for the sake of expediency, a underdeveloped accounting system destroy more than a half century of hard work. Robert Mladek