Chapter Twelve

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Chapter Twelve
Financial Reporting and the Securities and
Exchange Commission
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Securities and Exchange Commission (SEC)
Established by the Securities Exchange Act of
1934.
Independent Agency of the Federal Government
Mandate is to ensure that complete and reliable
information is available to investors
Direct authority Applies to Publicly
Held Companies
Major Influence on the Development of US GAAP
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Securities and Exchange Commission (SEC)
Headed by 5 commissioners appointed by the
President (with Senate consent)
Commissioners serve 5-year, staggered terms
Only 3 of 5 can belong to the same political party
The chairperson is usually from the same
political party as the President
Deposited over 1.076 Billion of fees in 2003
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Office of Information Technology
Office of the Chief Accountant
Division of Market Regulation
Division of Corporate Finance
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Federal Securities Laws
Spurred by the Great Depression following the
1929 Crash, Congress enacted
The 1934 Act Established the SEC
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Goals of the SEC

• Prohibiting dissemination of materially misstated
  information.

• Ensuring full fair disclosure to all investors.

• Preventing misuse of information by inside
  parties.

• Regulating the operation of securities markets.

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Full and Fair Disclosure
Requires continuous reporting by publicly traded
companies.
New securities must be registered prior to public
sale.
Prohibits fraudulent and unfair behavior.
Requires registration of interstate holding
companies of public utilities.
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Full and Fair Disclosure
Trust Indenture Act of 1939
Investment Advisers Act of 1940 and Securities
Investor Protection Act of 1970
Requires registration of indentures related to
public issue of bonds, notes, etc.
Requires registration of investment advisors and
requires them to follow certain standards.
Investment Company Act of 1940
Requires registration of investment companies.
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Full and Fair Disclosure
Foreign Corrupt Practices Act of 1977
Insider Trader Sanctions Act of 1984 Insider
Trader and Securities Fraud Enforcement Act of
1988
Amends Securities Exchange Act of 1934. Requires
maintenance of accounting records and adequate
internal accounting controls.
Increase penalties against persons who profit
from illegal use of inside information.
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Shaken Confidence

• During 2001 and 2002, numerous corporate scandals
  shook the confidence of investors in the
  reliability of financial statement information
• Causes included
• Greed on the part of corporate executives
• Failure of corporate governance
• Audit failures
• Unreasonable market expectations
• Overburdened SEC

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Full and Fair Disclosure
Sarbanes-Oxley Act of 2002
E
Designed as a response and answer to the numerous
corporate accounting scandals that came to light
in 2001 and 2002.
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The SECs Impact on Financial Reporting
In addition to audited financial statements,
Rule 14c-3 of the 1934 Act requires the following
to be included in proxy statements received by
shareholders

• 5-year summary of operations.
• Description of the business activities.
• 3-year summary of industry segments.
• Listing of company directors and executive
  officers.
• Market price of the common stock for each quarter
  of the last 2 years.
• Restrictions on the companys ability to pay
  dividends.
• MDA

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The SECs Impact on Financial Reporting

• All nonaudit services provided by the independent
  auditing firm.
• Whether the Board of Directors approved all
  nonaudit services and considered whether they
  would impair the auditors independence.
• The of nonaudit fees to the total annual audit
  fee.
• Individual nonaudit fees gt 3 of the annual audit
  fee.

Certain information about the auditor must also
be disclosed.
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Corporate Scandals Led to Sarbanes-Oxley in July
2002
WorldCom Improperly Added 9 Billion of Income
Enron Ken Lay received 152.7 Million in the
year His firm collapsed, Zeroing out pensions
Adelphia Communications founder looted the
company of Over 2 Billion
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Sarbanes-Oxley Act of 2002 Section 101
Creation of Public Company Accounting Oversight
Board

• Under the oversight and enforcement authority of
  the SEC
• Board charged with
• Establishing auditing, quality control, and
  independence standards.
• Performing periodic inspections of registered
  public accounting firms.
• Could potentially replace the Auditing Standards
  Board of the AICPA.

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Sarbanes-Oxley Act of 2002 Section 101
Creation of Public Company Accounting Oversight
Board

• Five members
• Allows only 2 of the 5 to be CPAs, past or
  present.
• Remaining 3 must NOT be accountants.
• The Board will be funded through mandatory fees
  levied on all publicly traded companies.
• Accounting firms must register with the Board and
  pay fees.
• Applies to foreign firms as well.

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Sarbanes-Oxley Act of 2002 Auditor Independence
To ensure future independence of audit firms,
some previously common concurrent services are
now prohibited.

• Bookkeeping services.
• AIS design and implementation.
• Appraisal or valuation services.
• Internal audit outsourcing.
• Management functions/Human Resource Management.
• Investment advising.
• Legal services or expert services.

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Sarbanes-Oxley Act of 2002Audit Committees
Audit Committees will also be expected to
exercise more oversight in the future.

• Financial Experts on the BOD must be identified
  in the annual report.
• Experience with accounting matters like the ones
  used in the company.
• Must have served as an auditor, CFO, controller,
  or Chief Accounting Officer of a public company.
• Independence of financial experts must be
  disclosed.
• The Committee hires the external auditor.
• The auditor now reports to the Committee instead
  of to management.

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SEC Requirements
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The SECs Authority Over GAAP
Authority only extends to publicly traded
companies.
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The SECs Authority Over GAAP
The SEC does issue authoritative documents.
Financial Reporting Releases (FRRs)
Staff Accounting Bulletins (SABs)
Supplements to Regulations S-K and S-X
Views on current accounting and disclosure
matters.
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Filings with the SEC
Two basic categories of filings
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Common SEC Registration Statement Forms
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Registration Process
Note This process is both time-consuming and
expenive.
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Registration Requirements

• PART I
• Audited financial Statements.
• An explanation of the use of the proceeds.
• A description of the security risks.
• A description of the business.

General contents of SEC registration reports.

• PART II
• Used by the SEC staff.
• Includes additional information about the company.

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Offerings Exempt from SEC Filing

• Securities issued by governments, banks, and
  SLs
• Securities issued that are restricted to a
  companys own existing shareholders.
• Offerings lt 5 million
• Securities issued by non-profit organizations

• Offerings lt 1 million to be made within a
  12-month period.
• Offerings lt 5 million made to 35 or fewer
  investors within a 12-month period.
• Private placement of securities to lt 36 investors
  who already have knowledge of the company.

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Periodic Filings with the SEC
Form 10-Q
Form 10-K
Quarterly report filed within 45 days of end of
quarter. Financial statement are unaudited.
Annual report filed within 90 days of fiscal
year-end. Includes audited financial statements.
Form 8-K
Used to disclose a unique or significant
happening.
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Proxy Statements

• A document that allows the board of directors to
  vote on behalf of a stockholder.
• Must be filed with SEC 10 days prior to
  distribution.

• Needs to indicate on whose behalf the
  solicitation is made.
• Must disclose fully all matters that are to be
  voted on at the meeting
• Has to be accompanied by an annual report
  (usually)

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EDGAR

• EDGAR is the acronym for the SECs Electronic
  Data Gathering and Retrieval System
• Designed to reduce the overwhelming paper flow
  into the SEC
• Allows for public access to SEC filings and
  information through the Internet

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Summary

• The SEC, created in the depths of the Great
  Depression, has been entrusted with the oversight
  of public capital markets in the United States
• The SEC has enormous influence over accounting
  practices and has the legal authority to
  establish GAAP
• Recent corporate scandals led to the
  Sarbanes-Oxley Act of 2002, which has radically
  altered the accounting oversight function in the
  United States

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Possible Criticisms

• The PCAOB, which now oversees auditing in the
  United States, has a majority of non-accountants.
  This has overturned the American accounting
  tradition of professional self-regulation, which
  has attracted much critical attention.
• The SEC has deflected much of the criticism for
  the corporate scandals of the early 2000s onto
  the auditing profession. Some critics feel that
  it is the SEC which needs an overhaul.
• WHAT DO YOU THINK????

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End of Chapter 12
That was fun! Can we do it again?