Advanced financial accounting by baker chapter 14

History of Securities Regulation• 1911 – States began passing what were called “blue sky laws” to regulate the offering of securities by companies which did not have a sound financial

SEC Reporting

14

• The Securities and Exchange Commission

(SEC) is an independent federal agency

created in 1934 responsible for regulating

securities markets

• The ability of companies to raise capital in

the stock markets and the high trading

volumes are indications of the SEC’s

success in maintaining an effective

marketplace for companies issuing

securities and for investors seeking capital

investments

History of Securities Regulation

• Thirteenth century – King Edward

establishes a Court of Aldermen to regulate security trades in London

• Eighteenth century – England’s Parliament

passed several acts (the Bubble Acts), to

control questionable security schemes

• 1790 – Creation of the New York Stock

Exchange

History of Securities Regulation

• 1911 – States began passing what were

called “blue sky laws” to regulate the

offering of securities by companies which

did not have a sound financial base

• 1920s – Era of heavy stock speculation by

many individuals

• The Great Depression

• The Federal Securities Acts of 1933 and

1934

History of Securities Regulation

• The Securities Act of 1933

– Regulated the initial distribution of security issues by

requiring companies to make “full and fair” disclosure

of their financial affairs before their securities could be offered to the public

• The Securities Exchange Act of 1934

– Required all companies whose stocks were traded on

a stock exchange to periodically update their financial information

– Created the Securities and Exchange Commission

and assigned it the responsibility of administering both the 1933 and 1934 acts

History of Securities Regulation

• The SEC has the legal responsibility to

regulate trades of securities and to

determine the types of financial disclosures that a publicly held company must make

• The SEC’s role is to ensure full and fair

disclosure; it does not guarantee the

investment merits of any security

EDGAR System

• EDGAR (Electronic Data Gathering,

Analysis, and Retrieval)

– An electronic filing system developed by the

SEC– Under this system, firms electronically file

directly by using computers, facilitating the data transfer and making public data more quickly available

International Harmonization of Accounting

Standards for Public Offerings

• The International Accounting Standards

Board (IASB) is working with the Financial

Accounting Standards Board (FASB) to

converge on a uniform set of accounting

and financial reporting standards that can

be used by all companies seeking financing through any of the world’s major stock

markets, including those of the United

States

International Harmonization of Accounting

Standards for Public Offerings

• In 2007, the SEC published Securities Act Release

No 33-8879

– Under this, financial statements from foreign private

issuers will be accepted by the SEC without reconciliation to U.S GAAP, if they are prepared using IFRSs as issued by the IASB

• Securities Act Release No 33-8831

– A Concept Release

– If U.S issuers are allowed to use IFRSs in their filings

with the SEC, multinational U.S companies operating

in several countries could use just one set of accounting and financial reporting standards for all of their global operations

Securities and Exchange Commission

• Organizational structure

– Division of Corporation Finance – Develops and

administers the disclosure requirements for the securities acts and reviews all registration statements and other issue-oriented disclosures

– Division of Enforcement – Directs the SEC’s

enforcement actions – Division of Investment Management – Regulates

investment advisers and investment companies – Division of Market Regulation – Regulates national

securities exchanges, brokers, and dealers of securities

Securities and Exchange Commission

• Organizational Structure of the SEC

Securities and Exchange Commission

• Laws administered by the SEC

– Public Utility Holding Company Act of 1935

– Trust Indenture Act of 1939

– Investment Company Act of 1940

– Investment Advisors Act of 1940

– Securities Investor Protection Act of 1970

– Sarbanes-Oxley Act of 2002

• The SEC is often asked for assistance in the

administration of two other major laws:

– Foreign Corrupt Practices Act of 1977

– Federal Bankruptcy Acts

Securities and Exchange Commission

• The regulatory structure

– Regulation S-X and Regulation S-K, govern

the preparation of financial statements and associated disclosures made in reports to the SEC

– Regulation S-X presents the rules for

preparing financial statements, footnotes, and the auditor’s report

– Regulation S-K covers all nonfinancial items,

such as management’s discussion and analysis of the company’s operations and financial position

Securities and Exchange Commission

• The regulatory structure

– The Accounting and Auditing Enforcement

Releases (AAERs) present the results of enforcement actions taken against

accountants, brokers, and other participants in the filing process

– The Staff Accounting Bulletins (SABs) allow

the SEC staff to make announcements on technical issues with which it is concerned as

a result of reviews of SEC filings

The Regulatory Structure

The Regulatory Structure

Issuing Securities: The Registration

Process

• Companies wishing to sell debt or stock securities

in interstate offerings to the general public are

generally required by the Securities Act of 1933 to register those securities with the SEC

– The basic financial statements required are:

– Prior years’ statements are presented on a

comparative basis with those for the current period – The SEC requires at least five years of selected

financial information presenting key numbers

Issuing Securities: The Registration

Process

• A number of types of securities and securities transactions are

exempt from registration:

only within one state

shareholders with no commission charged

loan associations, farmers, co-ops, and common carriers regulated by the Interstate Commerce Commission

organizations

• The antifraud provisions of the securities acts still apply

Issuing Securities: The Registration

Process

• Small issues under the SEC’s Regulation A

for issuances up to $5,000,000 within a

12-month period can be exempt if there is a

notice filed with the SEC and an “offering

circular” containing financial and other

information provided to the persons to

whom the offer is made

• Some required disclosures of financial

statements and other financial information

fall under Regulation A

Issuing Securities: The Registration

Process

• Regulation D presents three exemptions from full

registration requirements for private placements:

– Rule 504 exempts small issuances up to $1,000,000

within a 12-month period to any number of investors – Rule 505 exempts issuances up to $5,000,000 within

a 12-month period

investors” and to an unlimited number of “accredited investors”

– Rule 506 allows private placements of an unlimited

amount of securities and applies, in general, the same rules of Rule 505 except the maximum of 35

unaccredited investors must be sophisticated investors

Issuing Securities: The Registration

Process

• Offering process begins with the selection

of an investment banker (“underwriter”)

– Underwriter provides marketing information

and directs the distribution of the securities– The underwriting agreement specifies such

items as the underwriter’s responsibilities and the final disposition of any unsold securities

Issuing Securities: The Registration

Process

• The Registration Statement

– The process of public offerings of securities begins

with the preparation of the registration statement – The company must select one from among

approximately 20 different forms the SEC currently has for registering securities

– The most common are:

have other publicly traded stock

registrants whose stock has been trading for several years

Issuing Securities: The Registration

Process

– Form S-1 has two different levels of disclosure

investors

– The statement must be signed by the principal

executive, financial, and accounting officers,

as well as a majority of the company’s board

of directors

– The company then submits its registration

statement to an SEC review by the Division of Corporation Finance

Issuing Securities: The Registration

Process

• SEC review and public offering

– Most first-time registrants receive a

“customary review,” which is a thorough examination by the SEC that may result in:

must be corrected

– Established companies that already have

stock widely traded generally are subject to a summary review or a cursory review

Issuing Securities: The Registration

Process

• SEC review and public offering

– Once the registration statement becomes effective,

the company may begin selling securities to the public – This review period is 20 days unless the company

receives a comment letter from the SEC – Between the time the registration statement is

presented to the SEC and its effective date, the company may issue a preliminary prospectus (a red herring prospectus), which provides tentative

information to investors about an upcoming issue

Issuing Securities: The Registration

Process

– The company prepares a “tombstone ad” in

the business press to inform investors of the

upcoming offering

– The time period between the initial decision to

offer securities and the actual sale may not

exceed 120 days

Issuing Securities: The Registration

Process

• Shelf registration rule:

– For large, established companies with other

issues of stock already actively traded– These companies may file a registration

statement with the SEC for a stock issue that may be “brought off the shelf ” and, with the aid of an underwriter, updated within a very short time, usually two to three days

Issuing Securities: The Registration

Process

• Accountants’ legal liability in the registration

process

– Under section 11 of the 1933 act, accountants are

liable for any materially false or misleading information

to the effective date of the registration statement

– The underwriters handling the sale of the securities

often require a “comfort letter” from the registrant’s public accountants for the period between the filing date and the effective date

– This letter provides additional evidence that the public

accountant has not found any adverse financial changes since the filing date

Periodic Reporting Requirements

• Companies with more than $10 million in

assets and whose securities are held by

more than 500 persons must file annual and other periodic reports as updates on their

economic activities

• The three basic forms used for this updating

are Form 10-K, Form 10-Q, and Form 8-K

Periodic Reporting Requirements

• Form 10-K is the annual filing to the SEC

– “Accelerated filers” must file their Form 10-K

within 60 days after the end of the company’s fiscal year

– Small businesses, and others who do not

meet the requirements for an accelerated filer, have until 90 days after the end of their fiscal years

Periodic Reporting Requirements

• Form 10-K has four parts

– Parts I, II, and III include:

control structure and the assessment of the effectiveness of those controls

information disclosures

– Part IV contains additional schedules and

exhibits

Periodic Reporting Requirements

• Form 10-Q is the quarterly report to the

SEC

– Accelerated filers must file a Form 10-Q within

35 days after the end of each of their first three quarters

– Other companies must file within 45 days after

the end of each of their first three quarters– No Form 10-Q is filed for the fourth quarter

because that is when the Form 10-K is filed

Periodic Reporting Requirements

• Form 10-Q has two parts

– Part I includes comparative financial

statements prepared in accordance with APB 28

– Part II is an update on significant matters

occurring since the last quarter

• Form 8-K is used to disclose unscheduled

material events

– Companies must file a Form 8-K within four

business days of the occurrence of a

“triggering event”

Periodic Reporting Requirements

– Filed by those who acquire a beneficial ownership of

more than 5 percent of a class of registered equity securities and must be filed within 10 days after such

an acquisition – Beneficial ownership - Directly or indirectly having the

power to vote the shares or investment power to sell the security

– Materials submitted to shareholders for votes on

corporate matters – In many cases, voting on these matters takes place at

the annual meeting but it may also occur at a special

Periodic Reporting Requirements

• Accountants’ legal liability in periodic

reporting

– The 1934 Securities Exchange Act provides

for a limited level of legal exposure from involvement in the preparation and filing of periodic reports

– Civil liability is imposed for filing materially

false or misleading statements– Accountants are provided with due diligence

defenses

Foreign Corrupt Practices Act of 1977

• Congress passed the Foreign Corrupt

Practices Act of 1977 (FCPA) as a major

amendment to the Securities Exchange Act

of 1934

• The FCPA has two major sections:

– Part I prohibits foreign bribes

– Part II requires publicly held companies to

maintain an adequate system of internal control and accurate records

Sarbanes-Oxley Act of 2002

• Signed into law on July 30, 2002

– Gained impetus after the revelations about

accounting and financial mismanagement at Enron, WorldCom, and others

– The legislation (broadly known as SOX) has a

number of major implications for accountants

Sarbanes-Oxley Act – Major Sections

• Title I: Public Company Accounting Oversight Board

• Title II: Auditor Independence

• Title III: Corporate Responsibility

• Title IV: Enhanced Financial Disclosures

• Title V: Analyst Conflicts of Interest

• Title VI: Commission Resources and Authority

• Title VII: Studies and Reports

• Title VIII: Corporate and Criminal Fraud Accountability

• Title IX: White-Collar Crime Penalty Enhancements

• Title X: Sense of Congress Regarding Corporate Tax Returns

• Title XI: Corporate Fraud and Accountability

Disclosure Requirements

• Management Discussion and Analysis

– MD&A of a company’s financial condition and

results of operations is part of the basic information package required in all major filings with the SEC

– The items now required in the MD&A are:

liquidity, capital resources, results of operations, off-balance sheet arrangements, tabular disclosure of contractual obligations

Disclosure Requirements

• Pro forma disclosures

– Essentially “what-if ” financial presentations

often taking the form of summarized financial statements

– They show the effects of major transactions

that occur after the end of the fiscal period or that have occurred during the year but are not fully reflected in the company’s historical cost financial statements