BAKER LEMBKE KING advanced financial accounting 8e chapter 014

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

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• 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

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

a stock exchange to periodically update their financial information

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

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

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

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

enforcement actions

investment advisers and investment companies

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

• The SEC is often asked for assistance in the

administration of two other major laws:

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

comparative basis with those for the current period

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:

within a 12-month period to any number of investors

a 12-month period

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

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

with the preparation of the registration statement

approximately 20 different forms the SEC currently has for registering securities

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

• Part I: “Prospectus,” is intended primarily for

investors

• Part II includes more detailed information

– 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:

• Acceptance, or

• A comment letter specifying the deficiencies that

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

the company may begin selling securities to the public

receives a comment letter from the SEC

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

liable for any materially false or misleading information

to the effective date of the registration statement

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

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:

• The management’s discussion and analysis

• The audited financial statements and footnotes

• The report by management on the internal

control structure and the assessment of the effectiveness of those controls

• The auditor’s opinion

• At least five years of condensed financial

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

• Schedule 13D

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

an acquisition

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

• Proxy statements

corporate matters

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