CONVERTING TO IFRS: A U.S. PERSPECTIVE

1. CONVERTING TO IFRS: A U.S. PERSPECTIVE Robert D. Strahota Assistant Director, Office of International Affairs U.S. Securities and Exchange Commission Russian Corporate Governance Roundtable Moscow November 11-12, 2004 As a matter of policy, the Commission disclaims responsibility for any private publications or statements by any of its employees. The views expressed are those of the speaker and do not necessarily reflect the views of the Commission, individual commissioners or the speaker’s colleagues on the staff of the Commission.

2. This Presentation Covers: • Principal steps that have been taken in the U.S. to facilitate the development and use of international financial reporting standards (IFRS), including conversion issues that may be of relevance to other countries planning to adopt IFRS • U.S. efforts to foster high quality, internationally acceptable accounting and auditing standards • Some thoughts on where we are in the process

3. SEC and International Financial Reporting Standards • SEC continues to work directly and through the International Organization of Securities Commissions (IOSCO) to encourage the adoption and use of high quality IFRS • Observed meetings of the former IASC • Supported 2000 IOSCO resolution re use of 30 core international accounting standards (IAS) in cross border offerings and listings • Participates in accounting standards improvement projects • Involved in restructuring and creation of IASB • Observes standards-setting and interpretation work of new IASB • SEC has already accepted use of IFRS by foreign companies with reconciliation to U.S. GAAP • SEC has already accepted three IAS without reconciliation; IAS No. 7 (cash flow statements), No. 22 (business combinations) and No. 21 (operations in hyperinflationary economies)

4. Foreign Companies’ Conversion to IFRS • Less than 50 of 1200+ foreign companies now use IFRS in their SEC reports • All of the six Russian companies subject to SEC filing requirements have elected to prepare their financial statements using U.S. GAAP • Per a September 2003 EU regulation, IFRS will be required effective January 1, 2005 for approximately 7,000 EU companies, including approximately 450 EU companies that file reports with the SEC • Many other jurisdictions also are converting to IFRS as of this date • To accommodate IFRS conversion for foreign companies that file SEC reports, the SEC issued proposals in February 2004 that would permit filing of two instead of three years of IFRS financial statements in the first annual report filed by a foreign issuer in accordance with IFRS

5. SEC Proposals re Conversion to IFRS • Proposals would apply to companies adopting IFRS for the first time, and no later than calendar 2007 • Proposals would require a company must to state unreservedly and explicitly that its general-purpose financial statements comply with IFRS; the audited financial statements may not be subject to any qualification relating to the application of IFRS. • If IFRS are used, reconciliation to US GAAP would still be required • All audited financial statements filed with SEC must be audited in accordance with U.S. generally accepted auditing standards (which now means auditing standards of the PCAOB) (U.S. GAAS), and U.S. independence rules apply • SEC staff will review the expanded universe of IFRS-based reports in considering future acceptance of IFRS reporting without US GAAP reconciliation

6. Key Issues Relating to Conversion • The SEC proposals, IFRS and CESR guidance identify several key issues raised by conversion, although there is not complete agreement regarding resolution • IFRS give rise to a new basis of accountability and would require disclosure regarding reconciliation of IFRS balance sheet and income statement information to previous GAAP information • To provide at least three years of comparable data, the SEC proposals would require companies presenting only two years of IFRS financial statements in the transition year report to include a note to the audited financial statements which presents three years’ US-GAAP condensed balance sheet and income statement data without any required footnote explanation.

7. Key Issues Relating to Conversion - continued • Interim financial statements during the first year of IFRS • Foreign companies are not required to file interim financial reports with the SEC, but if interim financial information were required, e.g., in an offering document because of the age of audited financial statements, SEC proposals would require comparative interim period information in accordance with or reconciled to U.S. GAAP • CESR guidance would not preclude use of previous GAAP for interim financial statements but indicates a preference for reporting on the basis of IAS 34 or IAS/IFRS recognition and measurement principles that will be used for year-end IFRS financial statements • SEC proposals would require MD&A to focus on the IFRS financial statements, would prohibit side-by side comparisons of IFRS and previous GAAP information and would require cautionary language where previous GAAP information is used; CESR guidance would permit side-by-side comparisons with explanatory reconciliation

8. Effect of EU Conversion to IFRS on Non –EU Companies • EU regulation requiring conversion to IFRS provides that EU member states to exempt non-EU companies from IFRS requirements up to 2007 in the case of: • Companies that are listed both in EU and on a non-EU exchange and are using another set of internationally accepted standards • Companies that have only publicly-traded debt securities • In light of the 2007 deadline, on June 29, 2004 EC issued a mandate to CESR to assess the equivalence with IFRS of U.S. GAAP, as well as Canadian and Japanese standards CESR-Fin, a standing committee of CESR, will direct the work and report to CESR • Resolution of this issue will affect the attractiveness of EU markets; e.g., Eurobonds

9. SEC-CESR Cooperation Will Improve International Coordination in Implementing and Enforcing Use of IFRS • 2004 Memorandum of Understanding between CESR and the SEC provides for consultation and cooperation on a wide range of issues affecting the organizations’ constituencies • IFRIC will be responsible for issuing IFRS interpretations but individual country regulators do not relinquish their authority to interpret and enforce IFRS • It is expected that potential conflicts regarding interpretation and enforcement of IFRS will minimized by SEC-CESR consultation, and also by consultation within IOSCO

10. IOSCO Initiatives Regarding the Financial Reporting Process and Its Oversight • May 2000 IOSCO resolution recommending that IOSCO members permit the use of 30 core IAS, supplemented by reconciliation, disclosure and interpretation, for cross border offerings and listings • In light of the many changes that have been made in the core IAS as well as adoption of new standards, an updated IOSCO resolution is being prepared to support IFRS as a whole, support IASB’s independence, and explain IOSCO’s role vis a vis IFRS and the IASB • In February 2004, the IOSCO Technical Committee approved a Regulatory Interpretations of IFRS Project with the goal of encouraging cooperation and consultation among IOSCO members in the application and interpretation of IFRS. IOSCO Standing Committee 1 is to develop a consultation to be circulated to all IOSCO members regarding this project

11. IOSCO’s Position on Auditor Oversight • IOSCO’s October 2003 Statement of the Technical Committee regarding Principles of Oversight reflects international consensus that within each jurisdiction auditors, auditing standards, independence, ethical standards and quality control procedures, should be • subject to oversight by a regulatory body that “acts and is seen to act in the public interest” and that • disciplinary processes carried out or overseen by a independent body that is not under the control of the auditing profession

12. SEC-PCAOB oversight of the auditing profession is one (not the only) model for auditor oversight • PCAOB is a non-profit organization whose five board members are appointed by the SEC after consultation with the Chairman of the Federal Reserve Board and Secretary of the Treasury; no more than two board members may come from the auditing profession • PCAOB has authority to establish audit standards, related attestation standards, and independence quality control and ethics standards to be used by registered public accounting firms in audits of public companies’ financial statements filed with SEC • PCAOB has comprehensive authority to inspect, investigate, require reports, testimony and documents from, and sanction registered public accounting firms and associated persons for violations of SOX, securities laws and professional standards, including failure to reasonably supervise associated persons and failure to cooperate with an investigation • SEC’s oversight authority includes: authority to approve and amend Board Rules; notice of Board investigations; authority to inspect and sanction the Board, including censure and removal of members; review of Board disciplinary actions; and oversight of the Board’s budget and funding process

13. Prospects for SEC Acceptance of IFRS Without U.S. GAAP Reconciliation • The SEC Concept Release, issued in February 2000, requested comment on issues relating to quality of the standards, interpretation, application, auditing, and enforcement • Importance of a global financial reporting infrastructure was emphasized, including: • A comprehensive body of standards • High quality of these standards, including: • Consistency • Transparency • Full disclosure • Rigorous interpretation and application of the standards • Assessment of the financial reporting infrastructure includes auditing and enforcement issues • International regulatory cooperation is critical

14. SEC Concept Release Aftermath • Comment letters expressed a variety of views • Accounting convergence work underway holds out tremendous potential for investors and companies seeking to allocate and raise capital on a global basis • Adoption of IFRS to occur in European Union and some other countries should provide answers to some of the questions raised in the concept release • SEC staff currently considering steps that would need to be taken to eliminate reconciliation from IFRS to U.S. GAAP • No specific timetable has been adopted.

15. Convergence of Accounting Standards • IASB and FASB October 2002 MOU re convergence of IFRS and U.S. GAAP • Convergence is being implemented in several ways, including: • Short term efforts focused on discrete areas where it is possible to readily identify the best standard • An IASB representative at the FASB • Joint projects on major, fundamental areas • Longer term research, studies and projects to come • Consideration of convergence potential in all FASB decisions • Convergence dialogue has identified the need for a single conceptual framework (a longer-term project now underway) • Unfortunately, convergence can be affected by politics; e.g. EU acceptance of IAS 39 and 32, now compromised, and U.S. accounting for stock options, now deferred for six months • SEC fully supports convergence efforts and believes the focus should be on developing high quality standards. It does not view convergence as a “one way street” and is prepared to accept convergence from a U.S. GAAP standard to a better IFRS, but SEC also opposes “lowest common denominator” convergence

16. SEC Chief Accountant Donald T. Nicolaisen recently stated:“In order to realize the benefits of truly international financial reporting, we need convergence in all areas --- accounting, auditing and disclosures.”

17. Where Are We in the Process? • Progress in all three of these areas is encouraging • The global infrastructure for IFRS is substantially in place in light of IASB’s reorganization and related efforts underway to coordinate interpretation and enforcement of IFRS • The EU’s decision to use IOSCO’s Nonfinancial Disclosure Standards as the base level for disclosure in the EU’s Prospectus Directive and the SEC’s earlier adoption of these standards has contributed substantially to their international acceptance • While encouraging, progress regarding the global infrastructure for auditing standards is not complete. IFAC is not a body independent of the auditing profession and efforts to establish a Public Interest Oversight Board overlay are ongoing • There much less consensus over what constitutes high quality, international acceptable auditing standards and what changes need to made in current International Standards of Auditing

18. The Sarbanes-Oxley (SOX) Response to Auditing Failures in the U.S. Has Significantly Changed U.S. Auditing Standards • On May 27, 2003, the SEC implemented Section 404 of SOX by requiring domestic and foreign issuers to include in their annual reports a management report on internal control over financial reporting, Among other things, the report must include: • Management’s assessment of the effectiveness of the internal control as of the end of the last fiscal year (any material weaknesses must be disclosed and if they exist, management cannot conclude that internal control is effective) • A statement that the issuer’s independent accountants have issued an attestation report on management’s assessment • SOX also required the PCAOB to adopt rules that will require the independent auditor to describe in its audit report the scope of its testing of the internal control structure and procedures of the company, and to present (in such report or in a separate report): • The findings of the auditor from such testing • An evaluation whether the internal control structure and procedures achieve substantially the principal internal accounting control requirements of the Securities Exchange Act of 1934

19. Changes in U.S. Auditing Standards • The new internal control audit requirement differs from the independent auditor’s existing obligation under U.S. GAAS to evaluate internal controls of the company for purposes of planning the scope of the audit; e.g., the requirement envisions that the internal control evaluation would encompass an evaluation of the effectiveness of a company’s audit committee • This requirement is in addition to the independent auditor’s obligation under SOX to attest to management’s report and assessment of the internal control structure and procedures for financial reporting • This new requirement has been characterized as a “sea change” and as “a breakthrough that requires an integrated approach to the audit process”. See PCAOB Standard No. 2 on audits of internal controls over financial reporting • Because this change in U.S. practice is so new and has yet to gain international acceptance, it suggests a scenario whereby any U.S. acceptance of IFRS is likely to still require adherence to U.S. GAAS, as now prescribed by the PCAOB

20. Thank you • Questions?