Auditors and Financial Officers of companies who raise capital with complex financial instruments often find themselves drowning in convoluted accounting issues and restatements. Avoid the confusion by attending the live workshop, Debt vs. Equity Accounting for Complex Financial Instruments being held May 25th in New York City and June 23rd in San Francisco. Through a detailed review of the accounting literature and numerous examples and case studies this Workshop will help you build the knowledge and experience to appropriately recognize, initially record and subsequently account for these complex financing tools
FINRA, the Financial Industry Regulatory Authority and how this Self-Regulatory Organization affects us are less well known aspects of being a public company. Perhaps you have seen a “FINRA list”, the list of people who have bought and sold your stock in the period surrounding a major change in your stock price. This is one of the tools that regulators use to search for insider trading. Or maybe you have read about how FINRA’s fines for broker/dealers are on a pace to set new records.
“FINRA is dedicated to investor protection and market integrity through effective and efficient regulation of the securities industry.
FINRA is not part of the government. We’re an independent, not-for-profit organization authorized by Congress to protect America’s investors by making sure the securities industry operates fairly and honestly.
We do this by:
writing and enforcing rules governing the activities of 3,895 securities firms with 641,761 brokers;
examining firms for compliance with those rules;
fostering market transparency; and
Our independent regulation plays a critical role in America’s financial system—by enforcing high ethical standards, bringing the necessary resources and expertise to regulation and enhancing investor safeguards and market integrity—all at no cost to taxpayers.
FINRA’s role does go beyond broker/dealers. They also say:
FINRA uses technology powerful enough to look across markets and detect potential abuses. Using a variety of data gathering techniques, we work to detect insider trading and any strategies firms or individuals use to gain an unfair advantage.
In fact, FINRA processes, on average, 50 billion—and up to 75 billion—transactions every day to build a complete, holistic picture of market trading in the United States.
We also work behind the scenes to detect and fight fraud. In addition to our own enforcement actions, in 2015, we referred more than 800 fraud and insider trading cases to the SEC and other agencies. When we share information with other regulators, it leads to important actions that prevent further harm to investors.”
With this level of referrals, they are clearly a proactive watchdog of the markets! We all need to know who they are and what they do.
As always, your thoughts and comments are welcome.
The SEC, on June 1, 2016, adopted an Interim Final Rule and Request for Comment to implement the Form 10-K summary provisions of The FAST Act. Passed earlier this year, the FAST Act contains a number of SEC reporting requirements, many of which the SEC has already implemented.
The Interim Final rule provides that a company may, at its option, include a summary in its Form 10-K. Each item in the summary must include a cross-reference by hyperlink to the material contained in the company’s Form 10-K to which the item relates.
The summary is a new Item 16 in Form 10-K:
Item 16. Form 10-K Summary.
Registrants may, at their option, include a summary of information required by this form, but only if each item in the summary is presented fairly and accurately and includes a hyperlink to the material contained in this form to which such item relates, including to materials contained in any exhibits filed with the form.
Instruction: The summary shall refer only to Form 10-K disclosure that is included in the form at the time it is filed. A registrant need not update the summary to reflect information required by Part III of Form 10-K that the registrant incorporates by reference from a proxy or information statement filed after the Form 10-K, but must state in the summary that the summary does not include Part III information because that information will be incorporated by reference from a later filed proxy or information statement involving the election of directors.
While perhaps not particularly dramatic, this is a nice step towards making Form 10-K a better communication tool, which is of course a big part of the disclosure effectiveness activities of the SEC. We could even debate whether such a rule is necessary as some companies, GE in particular, already provides such a summary.
You can read the Interim Final Rule and request for comment here.
And, if you have not read it recently, Carol and George, your bloggers, suggest taking a look here at the GE Form 10-K. You will find it interesting and the summary is on page 217.
As always, your thoughts and comments are welcome!
Last week we lightheartedly posted about the fun of listening to a live webcast of an SEC meeting and being “cool” and “in the know”. The meeting we mentioned is on April 13th and includes this agenda item:
The Commission will consider whether to issue a concept release seeking comment on modernizing certain business and financial disclosure requirements in Regulation S-K.
Concept releases explore issues and very frequently provide insight into the direction that future policy making will take. As an example you could check out the SEC’s recent concept release about audit committee disclosures in this post:
Also, in some words that may be familiar to folks who have attended our SEC Workshops, here is a quote about MD&A from FR 36:
The MD&A requirements are intended to provide, in one section of a filing, material historical and prospective textual disclosure enabling investors and other users to assess the financial condition and results of operations of the registrant, with particular emphasis on the registrant’s prospects for the future. As the Concept Release states:
The Commission has long recognized the need for a narrative explanation of the financial statements, because a numerical presentation and brief accompanying footnotes alone may be insufficient for an investor to judge the quality of earnings and the likelihood that past performance is indicative of future performance. MD&A is intended to give the investor an opportunity to look at the company through the eyes of management by providing both a short and long-term analysis of the business of the company. The Item asks management to discuss the dynamics of the business and to analyze the financials.
Most importantly, the SEC listens and very often thoughtfully takes into account the issues discussed in comment letters in their subsequent rulemaking. All this leads us to the conclusion, especially since the Disclosure Effectiveness process has been underway for quite a while, that this could be an important meeting!
If you would like to learn a bit more after the meeting, PLI will be presenting a One-Hour Briefing titled “SEC’s New Concept Release on Modernizing Regulation S-K” on April 25, 2016. Four speakers, including former CorpFin staffers, will present the briefing to help build a deeper understanding of the process. You can learn more at:
As always, your thoughts and comments are welcome!
In all our workshops and seminars, when we discuss the SEC review process we always emphasize that when you get a comment from the staff you do NOT immediately change disclosure in response to the comment. As the staff says in their on-line “Filing Review Process” document, they view the process of issuing comments as a “dialogue with a company about its disclosure”.
You can find the filing review process document, which is updated on a regular basis at:
To illustrate, here is a real life comment example.
STEP ONE – COMMENT RECEIVED
What would you do if you received this comment?
Reportable Segments, page 39
- Your segment discussion and analysis only refers to non-GAAP amounts. Pursuant to Item 10(e) of Regulation S-K, we remind you that more prominence should not be given to non-GAAP financial measures compared to GAAP financial measures. In this regard, please revise your discussion and analysis to first provide a discussion of the corresponding GAAP amounts for each segment ensuring equal prominence to that of your non-GAAP amounts.
The comment uses the language “please revise”, which is a bit scary, and in the back of our minds we hope we can push the comment to an “in future filings” comment if we decide the staff is on-point. The comment is focused on the use of non-GAAP measures in MD&A as discussed in operating segment disclosures. Of course, the use of non-GAAP measures in segment disclosures is appropriate if in fact your chief operating decision maker uses non-GAAP information. So, your first step in the research process for this comment might be to go review that part of ASC 280.
STEP TWO – REVIEW GAAP LITERATURE
Here is the relevant section:
50-27 The amount of each segment item reported shall be the measure reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segment and assessing its performance. Adjustments and eliminations made in preparing a public entity’s general-purpose financial statements and allocations of revenues, expenses, and gains or losses shall be included in determining reported segment profit or loss only if they are included in the measure of the segment’s profit or loss that is used by the chief operating decision maker. Similarly, only those assets that are included in the measure of the segment’s assets that is used by the chief operating decision maker shall be reported for that segment. If amounts are allocated to reported segment profit or loss or assets, those amounts shall be allocated on a reasonable basis.
ASC 280 then goes on to require disclosure about the measurement basis used for segment disclosures:
50-29 A public entity shall provide an explanation of the measurements of segment profit or loss and segment assets for each reportable segment. At a minimum, a public entity shall disclose all of the following (see Example 3, Cases A through C [paragraphs 280-10-55-47 through 55-49]):
- The basis of accounting for any transactions between reportable segments.
- The nature of any differences between the measurements of the reportable segments’ profits or losses and the public entity’s consolidated income before income taxes, extraordinary items, and discontinued operations (if not apparent from the reconciliations described in paragraphs 280-10-50-30 through 50-31). Those differences could include accounting policies and policies for allocation of centrally incurred costs that are necessary for an understanding of the reported segment information.
- The nature of any differences between the measurements of the reportable segments’ assets and the public entity’s consolidated assets (if not apparent from the reconciliations described in paragraphs 280-10-50-30 through 50-31). Those differences could include accounting policies and policies for allocation of jointly used assets that are necessary for an understanding of the reported segment information.
- The nature of any changes from prior periods in the measurement methods used to determine reported segment profit or loss and the effect, if any, of those changes on the measure of segment profit or loss.
- The nature and effect of any asymmetrical allocations to segments. For example, a public entity might allocate depreciation expense to a segment without allocating the related depreciable assets to that segment.
ASC 280 also includes this reconciliation requirement:
50-30 A public entity shall provide reconciliations of all of the following (see Example 3, Case C [paragraphs 280-10-55-49 through 55-50]):
- The total of the reportable segments’ revenues to the public entity’s consolidated revenues.
- The total of the reportable segments’ measures of profit or loss to the public entity’s consolidated income before income taxes, extraordinary items, and discontinued operations. However, if a public entity allocates items such as income taxes and extraordinary items to segments, the public entity may choose to reconcile the total of the segments’ measures of profit or loss to consolidated income after those items.
- The total of the reportable segments’ assets to the public entity’s consolidated assets.
- The total of the reportable segments’ amounts for every other significant item of information disclosed to the corresponding consolidated amount. For example, a public entity may choose to disclose liabilities for its reportable segments, in which case the public entity would reconcile the total of reportable segments’ liabilities for each segment to the public entity’s consolidated liabilities if the segment liabilities are significant.
With this, our review of the relevant GAAP literature is well underway, and substantially complete.
STEP THREE – REVIEW THE RELEVANT SEC NON-GAAP GUIDANCE
As you research the SEC’s requirements surrounding the use of non-GAAP measures, most of us are familiar with Reg G, which applies to non-GAAP measures in documents that are not filed, such as earnings releases. But this comment is about S-K Item 10(e) which applies to non-GAAP measures included in MD&A. As you read Item 10(e) you would find:
(5) For purposes of this paragraph (e), non-GAAP financial measures exclude financial measures required to be disclosed by GAAP, Commission rules, or a system of regulation of a government or governmental authority or self-regulatory organization that is applicable to the registrant. However, the financial measure should be presented outside of the financial statements unless the financial measure is required or expressly permitted by the standard-setter that is responsible for establishing the GAAP used in such financial statements.
Where to go from here? Lets get into the specific facts in the company’s Form 10-K.
STEP FOUR – APPLY THE RESEARCH TO THE COMPANY’S DISCLOSURES
Here is an excerpt from the company’s segment note:
“We prepared the financial results for our reportable segments on a basis that is consistent with the manner in which we internally disaggregate financial information to assist in making internal operating decisions. We included the earnings of equity affiliates that are closely associated with our reportable segments in the respective segment’s net income. We have allocated certain common expenses among reportable segments differently than we would for stand-alone financial information. Segment net income may not be consistent with measures used by other companies. The accounting policies of our reportable segments are the same as those applied in the consolidated financial statements.”
Here is an excerpt from the MD&A disclosure that the SEC comment is focused on:
When compared to the same period last year, core earnings increased in the twelve months ended December 31, 2013 by $202 million, or 13%, driven by the following items:
|·||Higher core earnings in the Optical Communications, Life Sciences,
Environmental Technologies and Display Technologies segments in the
amounts of $59 million, $44 million, $11 million and $7 million, respectively; and
Lower operating expenses in the amount of $49 million, driven by a decrease in
variable compensation and cost control measures implemented by our segments.
You can find the company’s Form 10-K at:
You can read the issues the SEC is commenting about in MD&A on page 39, and the segment note starts on page 137.
At this point we are ready to make an informed judgment about the comment. And this one follows a really twisty path! First, the MD&A clearly includes non-GAAP measures for “core” operations. And, interestingly, these are not the measures that are disclosed in the segment note in the financial statements. Since the measures used in the MD&A are not in the segment note the provision in S-K Item 10(e) excluding disclosures required under GAAP does not apply, and so the company must comply with the provisions. The next step is to, as we said above, make a case with the staff that it will be appropriate to fix this comment in future filings and not amend the current Form 10-K.
STEP FIVE – RESPOND TO THE COMMENT
Here is the company’s response to the comment, and the staff did allow this to become a future filings comment:
We acknowledge the Staff’s comments and, beginning with our Form 10-Q filed for the second quarter of 2014, will revise our future disclosure to ensure that more prominence is not given to non-GAAP financial measures when compared to GAAP financial measures. With respect to the request to revise our discussion and analysis to first provide a discussion of the corresponding GAAP amounts for each segment, we provide the following updated disclosure, which we propose to use in future filings.
You can read the response letter and the complete version of the response to comment 8 including the proposed disclosure at:
As always, your thoughts and comments are welcome!
In our One-Hour Briefing presenting our thoughts on key issues for 2016 Form 10-K’s we discussed Conflict Mineral Reporting. Companies need to continue to refine their reporting processes as they gain experience with the rule and also watch for developments in the continuing legal challenges to the rule.
The short and sweet news here is that not a lot has changed since last year. That said, since this is a calendar year reporting requirement for all companies with a May 31 due date, there is time for change to occur before the due date.
One are that is not different is that because of the April 2014 court decision, issuers are still not required to report whether any of their products have “not been found to be DRC conflict free”. You can review the SEC Order for the Partial Stay of the rule at:
Corp Fin issued a Statement about the Court of Appeals decision which is at:
And there are SEC FAQ’s available at:
The FAQ’s do provide some process guidance, but the bottom line is that this area is still evolving.
As always, your thoughts and comments are welcome!
PS You can review the Form 10-K Tune-up Briefing and obtain CLE and CPE credit at:
On November 3 we blogged about debt versus equity issues and how in late stage financings investors were demanding price adjustment and conversion rate adjustment features such as ratchet provisions. In essence this was to protect late round investors if the valuations they used for their investment was substantially higher than the IPO valuation.
As you may have been following, Square has just completed their IPO. Here is an excerpt from Square’s stockholder’s equity note in their financial statements:
The initial conversion price for the convertible preferred stock is $0.21627 for the Series A preferred stock, $0.71977 for the Series B-1 preferred stock, $0.95369 for the Series B-2 preferred stock, $5.79817 for the Series C preferred stock, $11.014 for the Series D preferred stock, and $15.46345 for the Series E preferred stock. In the event the Company issues shares of additional stock, subject to customary exceptions, after the preferred stock original issue date without consideration or for a consideration per share less than the initial conversion price in effect immediately prior to such issuance, then and in each such event the conversion price shall be reduced to a price equal to such conversion price multiplied by the following fraction:
the numerator of which is equal to the deemed number of shares of common stock outstanding plus the number of shares of common stock, that the aggregate consideration received by the Company for the total number of additional shares of common stock so issued would purchase at the conversion price immediately prior to such issuance; and
the denominator of which is equal to the deemed number of shares of common stock outstanding immediately prior to such issuance plus the deemed number of additional shares of common stock so issued.
Series E preferred stock contains a provision for the adjustment of conversion price upon a public offering. In the event of such offering, in which the price per share of the Company’s common stock is less than $18.55614 (adjusted for stock splits, stock dividends, etc.), then the then-existing conversion price for the Series E preferred stock shall be adjusted so that, as of immediately prior to the completion of such public offering, each share of Series E preferred stock shall convert into (A) the number of shares of common stock issuable on conversion of such share of Series E preferred stock; and (B) an additional number of shares of common stock equal to (x) the difference between $18.55614 and the public offering price, (y) divided by the public offering share price.
The language above is not very easy to understand, but there are various price adjustment features and the instruments that have them were entered into at various points in time, including some later stage investments. So, the debt versus equity issues is present.
Square’s IPO priced at $9, (actually below the expected price range, but the company did get a nice day one price rise on the exchange) so Square will have to make up shares to these later stage investors. This is a simple example where late stage financing valuations were higher than the IPO price.
Here are two links to information about the transaction. Buzzfeed has a nice summary of the deal at:
Here is a WSJ article where the WSJ somehow wanted to call this ratchet a “penalty”:
As always, your thoughts and comments are welcome!
P.S. And, just in case this is relevant to you, here is a link to our new workshop “Debt vs. Equity Accounting for Complex Financial Instruments”. This new case-driven workshop will be presented five times next year.
As you know the new FASB and IASB revenue recognition standards supersede all our existing revenue recognition guidance. Here in the US the new standard was such a major change that it was placed in a brand new codification section (ASC 606). One of the major changes with the new model is how it treats “specialized industries”. Many industries, such as software and construction, had specialized industry revenue recognition guidance. All those standards are also superseded. These industries now face many questions and uncertainties about how to apply the new revenue recognition model to unique and different transactions.
The new model, designed to make revenue recognition principles consistent across all industries, is much more general and does not include the detailed kind of guidance that old GAAP frequently provided. This potentially increases the risk that there could be diversity within industries in the application of the new standard.
FinREC, the Financial Reporting Executive Committee of the AICPA, and the AICPA’s Revenue Recognition Task Force have been working to help deal with these issues. They have established 16 industry groups and are developing a new “Accounting Guide for Revenue Recognition”. These resources will be developed with participation and review of standard setters, but will not be authoritative. The groups describe them as eventually providing “helpful hints and illustrative examples for how to apply the new Revenue Recognition Standard.”
They have published a list of potential implementation issues identified to date which you can find at:
As always, your thoughts and comments are appreciated!
As we all wait with baited breath for news from Norwalk as the FASB staff completes drafting the final version of the new standard on Lease Accounting, the IASB has announced that they have formally finished their project. In their project summary the IASB now states:
“The IASB has completed its decision making for the Leases project. The new Leases Standard will be effective from 1 January 2019. The IASB plans to issue the new Leases Standard before the end of 2015.”
You can find the project summary at:
- If the link above does not work for you, paste it into your browser.
In three previous posts about audit committee evolution we explored:
A bit of history about how audit committee responsibilities have changed over time,
Situations where independence issues have resulted in enforcement involving auditors and companies, and
How some issues, such as auditor independence, are not just matters for the auditor to monitor, but also may require audit committee involvement.
As history demonstrates, audit committees play a crucial role in oversight of the financial reporting process. An effective audit committee is a crucial part of assuring the reliability and reasonableness of financial information. Unfortunately, history also shows us that audit committees don’t always successfully fulfill their responsibilities.
Chair White expanded on these issues in a June 2014 speech to the Stanford University Rock Center for Corporate Governance Twentieth Annual Stanford Directors’ College. In that speech, after reviewing two enforcement cases which involved audit committee members she said:
I mention these cases because audit committees, in particular, have an extraordinarily important role in creating a culture of compliance through their oversight of financial reporting. As you know, under the Sarbanes-Oxley Act, audit committees are required to establish procedures for handling complaints regarding accounting, internal controls, and auditing matters, as well as whistleblower tips concerning questionable accounting or auditing practices. Audit committees also play a critical role in the selection and oversight of the company’s auditors. These responsibilities are critical ones and we want to support you. Service as a director is not for the faint of heart, but nor should it be a role where you fear a game of “gotcha” is being played by the SEC.
Clearly Ms. White is emphasizing the responsibility audit committees have as gatekeepers in the financial reporting process.
(You can read the whole speech at: www.sec.gov/News/Speech/Detail/Speech/1370542148863 )
All of this leads us to the SEC’s July 1, 2015 Concept Release “POSSIBLE REVISIONS TO AUDIT COMMITTEE DISCLOSURES”. Attempting to perhaps incentivize audit committees to perform effectively, and even more importantly shed light on audit committee performance to help investors and other stakeholders understand whether audit committees are effectively fulfilling their oversight responsibilities are not simple issues, and this concept release begins a significant discussion.
What sorts of disclosures does the concept release propose to deal with these issues? The principle areas of focus are:
Audit Committee’s Oversight of the Auditor
Audit Committee’s Process for Appointing or Retaining the Auditor
Qualifications of the Audit Firm and Certain Members of the Engagement Team Selected By the Audit
In the summary of the concept release the commission makes their objective clear, stating:
Some have expressed a view that the Commission’s disclosure rules for this area may not result in disclosures about audit committees and their activities that are sufficient to help investors understand and evaluate audit committee performance, which may in turn inform those investors’ investment or voting decisions.
The reporting of additional information by the audit committee with respect to its oversight of the auditor may provide useful information to investors as they evaluate the audit committee’s performance in connection with, among other things, their vote for or against directors who are members of the audit committee, the ratification of the auditor, or their investment decisions.
Here is a quick outline of the areas addressed in the Concept Release:
- Auditor Committee’s Oversight of the Auditor
- Additional Information Regarding the Communications Between the Audit Committee and the Auditor
- The Frequency with which the Audit Committee Met with the Auditor
- Review of and Discussion About the Auditor’s Internal Quality Review and Most Recent PCAOB Inspection Report
- Whether and How the Audit Committee Assesses, Promotes and Reinforces the Auditor’s Objectivity and Professional Skepticism
- Audit Committee’s Process for Appointing or Retaining the Auditor
- How the Audit Committee Assessed the Auditor, Including the Auditor’s Independence, Objectivity and Audit Quality, and the Audit Committee’s Rationale for Selecting or Retaining the Auditor
- If the Audit Committee Sought Requests for Proposal for the Independent Audit, the Process the Committee Undertook to Seek Such Proposals and the Factors They Considered in Selecting the Auditor
- The Board of Directors’ Policy, if any, for an Annual Shareholder Vote on the Selection of the Auditor, and the Audit Committee’s Consideration of the Voting Results in its Evaluation and Selection of the Audit Firm
- Qualifications of the Audit Firm and Certain Members of the Engagement Team Selected By the Audit Committee
- Disclosures of Certain Individuals on the Engagement Team
- Audit Committee Input in Selecting the Engagement Partner
- The Number of Years the Auditor has Audited the Company
- Other Firms Involved in the Audit
As you can see, the areas the SEC is considering for disclosure are significant and would represent a major change in how much of the audit committee’s work is in the sunshine of disclosure. Along this evolutionary path it is important to remember that a Concept Release is essentially a discussion document. If the SEC does pursue rulemaking, the content of a proposed rule will be based on input received in response to the concept release. The SEC is always responsive to substantive comments, so if a rule is eventually proposed, it will differ from the proposed rule based on comments from constituents. This means we are early on in this process, and we can provide input to the process.
As a concluding thought, if you do want to comment on the Concept Release, here is where to do that:
As always, your thoughts and comments are welcome!