Tuesday, August 5, 2008

Unintended Consequences of SEC's integration of interanational accounting standards

SEC Risks Confusion In Switch to Match Overseas Accounting Plenty of hedge funds are convinced that the Securities and Exchange Commission is out to get them by limiting short-selling, or bets that stocks will fall in value. But these investment managers should take heart. The commission is preparing other changes to the financial-reporting system that could sow the kind of confusion that allows hedge funds to flourish. SEC Chairman Christopher Cox wants U.S. companies to use international accounting standards. Of course, that isn't the SEC's intention. But it could prove an unintended consequence of the commission's expected plan to join U.S. companies with international peers in a common financial language. The SEC is expected to soon unveil proposals to put U.S. companies on track to adopt international accounting standards, eventually replacing U.S. rules. The swearing-in last week of the final two of the SEC's three new commissioners paves the way for Chairman Christopher Cox to move ahead with this long-awaited project. The commission Monday also plans to hold a round table on issues related to U.S. and international accounting systems and the subprime-mortgage crunch. The idea behind the effort is laudable: A single, global accounting system should make it easier for investors everywhere to understand company accounts. That, in turn, should spur global investment and lower companies' cost of capital. But based on public comments from commission staff in recent months, the SEC isn't expected to mandate that all U.S. public companies switch on a set date, which is the approach Europe took in 2005. Instead, companies that meet certain market-value or revenue criteria are likely to be able to choose between the two systems for a few years. That could lead to companies within the same sector reporting results differently, making comparisons difficult for all but the most sophisticated investors. Hedge funds, many of which specialize in the kind of deep-dive research that will be needed to ferret out the ensuing valuation anomalies, are likely beneficiaries, but average investors could suffer. Take research-and-development costs. In the U.S., companies have to expense these when they occur. Under international rules, companies expense research but capitalize, or spread out over time, development costs. The international approach can help flatter profits in the short term. Unless investors understand such differences, valuation comparisons will be off-base. The state of limbo wouldn't exist forever. The SEC is expected to say that all U.S. companies should switch to international rules, possibly as soon as 2013. But a future commission would have to pull the trigger on a final date, based on whether certain milestones have been met. The reality is that the time, expense and headaches involved with a wholesale system change will lead to stiff opposition. This could delay or even kill a complete move to international rules. Just look at the commission's continual postponement in applying internal-control rules to smaller public companies because of opposition from these concerns. The more likely outcome is that investors will be left to grapple with two different accounting systems. That will make life more difficult, and perhaps more costly, for average investors. If the SEC wants a system change, it shouldn't take half-steps. There are easier ways to make amends to hedge funds.

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