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Plaintiff Lawsuits – A Legal Proceedings Disclosure Tidbit

By: George M. Wilson, SEC Institute & Gary M. Brown, Partner, Nelson Mullins Riley & Scarborough LLP (Note: Gary Teaches our SEC Reporting and Practice Skills for Lawyers workshop)

In our Workshops, disclosures about legal proceedings are usually a hot topic for both lawyers and accountants. In these discussions we review the differences between the S-K Item 103 disclosures for legal proceedings and the ASC 450 GAAP disclosures for contingencies. The S-K Item 103 disclosures generally are more about the factual situation and include more details than the GAAP disclosures, including details such as the name of the parties, the court or jurisdiction where the action is taking place and the relief sought. The GAAP disclosures are more focused on expected impact.


One challenging aspect of these differences is what to disclose about plaintiff lawsuits. Generally, the GAAP disclosures focus on contingent liabilities, not the kind of contingent asset that would arise from a plaintiff lawsuit. The ASC guidance for gain contingencies is short and to the point:


450-30-25   Recognition



A contingency that might result in a gain usually should not be reflected in the financial statements because to do so might be to recognize revenue before its realization.  450-30-50   Disclosure



Adequate disclosure shall be made of a contingency that might result in a gain, but care shall be exercised to avoid misleading implications as to the likelihood of realization.


S-K Item 103 does not have this same focus on contingent liabilities. In fact, it starts with this language:


 Item 103 – Legal proceedings.


Describe briefly any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the registrant or any of its subsidiaries is a party or of which any of their property is the subject. Include the name of the court or agency in which the proceedings are pending, the date instituted, the principal parties thereto, a description of the factual basis alleged to underlie the proceeding and the relief sought. Include similar information as to any such proceedings known to be contemplated by governmental authorities.


The language “material pending legal proceedings” does not limit the disclosure to just defendant actions. And, to reinforce this conclusion, the SEC has issued the following Compliance and Disclosure Interpretation:

Section 205. Item 103 — Legal Proceedings

205.01 The bank subsidiary of a one bank holding company initiates a lawsuit to collect a debt that exceeds 10% of the current assets of the bank and its holding company parent. Due to the unusual size of the debt, Item 103 requires disclosure of the lawsuit, even though the collection of debts is a normal incident of the bank’s business. [July 3, 2008]

This C&DI also illustrates the application of the 10% disclosure threshold and an interesting interpretation about normal course of business issues. And, it clearly shows that Legal Proceedings disclosure should include material lawsuits in which the company is a plaintiff as well as a defendant.


As always, your thoughts and comments are welcome!


It’s time to update your SEC Reporting Skills!

GO-4049_SEC_Reporting_Skills_Wksp_800x469                                              SEC Reporting Skills Workshop

Designed for accounting and financial reporting professionals, this Workshop will help you build the foundational knowledge and practical experience necessary to prepare and review the SEC’s periodic and current reporting forms.

Attend a class being held in a location near you!

Upcoming workshops include:







Helping Audit Committees Grapple with Change

By: George M. Wilson, SEC Institute

Few corporate governance roles are more complex than that of the audit committee member. To help audit committee members and their advisors keep pace with

  • new GAAP standards for major areas, such as revenue recognition, lease accounting and financial instrument impairment;
  • new and evolving PCAOB regulations, such as the new auditors report and discussion of critical audit matters; and
  • an increased focus on risk management practices, particularly cybersecurity risk

PLI is offering its “Audit Committees and Financial Reporting 2018: Recent Developments and Current Issues” program on June 11, 2018. The program will be held at PLI’s New York Center and will also available via webcast and groupcast.


As always, your thoughts and comments are welcome!

Rule 3-13 Requests for Waivers – Yes, the SEC Really Means It!

By: George M. Wilson, SEC Institute

Last December we blogged about the SEC actively encouraging companies to consider requesting waivers of certain financial reporting requirements using an historically little mentioned provision of Regulation S-X. Rule 3-13 says:


  • 210.3-13   Filing of other financial statements in certain cases.

The Commission may, upon the informal written request of the registrant, and where consistent with the protection of investors, permit the omission of one or more of the financial statements herein required or the filing in substitution therefor of appropriate statements of comparable character. The Commission may also by informal written notice require the filing of other financial statements in addition to, or in substitution for, the statements herein required in any case where such statements are necessary or appropriate for an adequate presentation of the financial condition of any person whose financial statements are required, or whose statements are otherwise necessary for the protection of investors.

The SEC Chairman and the Director of the Division of Corporation Finance have mentioned this “waiver process” in several public forums, and there is a substantial amount of “buzz” about this change in approach by the staff in the community of registrants.


This report from Orrick is one example. Another is this “To the Point” update from EY.


The staff has described what they consider a preferred process for requesting these waivers, and they are responding to these requests in a very timely fashion, frequently within a week or ten days. To facilitate this process the staff put the following language at the very beginning of the introductory material in the CorpFin Financial Reporting Manual:

  • (The Division of Corporation Finance) Acts on behalf of the Commission to grant relief under Rule 3-13 of Regulation S-X. The staff has authority, where consistent with investor protection, to permit registrants to omit, or substitute for, required financial statements. Requests for this relief should be submitted by email. Call (202) 551-3111 and ask for the appropriate person listed below to discuss questions about potential relief:

Rule 3-05 – Patrick Gilmore

Article 11 – Todd Hardiman

Rules 3-09 and 4-08(g) – Christy Adams

Rules 3-10 and 3-16 – Tricia Armelin

Rule 3-14 – Jessica Barberich


To the above guidance we would add the advice to involve your auditors in this process as they may have helpful advice along the way and their opinion may be relevant to the SEC.


So, what are some typical situations where we should stop and consider whether or not to approach the staff about such a waiver request? Here are a few examples.


Significance tests – When applying the three significant subsidiary tests, in particular the income test, if an acquirer has very small income this part of the test could be met for an acquisition that may not really be “significant”. If one of the three parts of this test seems out of the norm then there may be other, more appropriate, considerations in making a determination whether separate financial statements are useful. This would be a great time to consider a Rule 3-13 request.

Pre-and post-acquisition periods for S-X rule 3.05 – When appropriate it may be best to use an analysis that is less mechanical and focuses on trend issues that are meaningful and which help assess how an acquisition may impact on post-acquisition results.

Predecessor/Successor issues – In some cases stub periods may not be as relevant or reliable carve out F/S may not be possible to build. For example, it may be that abbreviated financial statements may provide the information that investors need in this type of situation.

IFRS financial statements may be acceptable for some acquisitions and equity method investees – if a company could be a foreign private issuer the staff may accept IFRS financial statements.

Mechanical compliance with a rule sometimes is not the best way to provide investors with the information they need. It is a good thing to know that there are alternatives. So, when you think you are in this situation, go talk to the staff!





A Post More for Lawyers – Words Are Important “Except” When They Are Not


By Gary M. Brown, Partner, Nelson Mullins Riley & Scarborough LLP (Note: Gary Teaches our SEC Reporting and Practice Skills for Lawyers workshop)

On March 20, 2018, the U.S. Supreme Court decided Cyan, Inc. et al. v. Beaver County Employees Retirement Fund. The question in this case was the extent to which SLUSA (the Securities Litigation Uniform Standards Act) preempts litigation of claims under the Securities Act of 1933 (the “’33 Act”) in state as opposed to federal courts. Short answer – it doesn’t – at all.

The decision is more of a grammatical exercise (and an example of poor Congressional draftsmanship) than it is a work of judicial scholarship. The decision focused on two sections of SLUSA found in section 16 of the ’33 Act and two sentences in Section 22 (Jurisdiction of Offenses and Suits) of the ’33 Act.

Sections 16(b) and 16(c) provide, respectively, that class actions based on state securities law claims[1] in connection with the purchase or sale of “covered securities”[2] may not be maintained in any state or federal court (the “State Law Bar”) and that any such suit (a class action based on state securities law claims) involving a “covered security,” if brought in state court, is removable to federal court where, presumably it will be dismissed (the “Removability Provision”).

NOTE – simply stated, the sections apply to class actions based on state securities law claims

Beaver County’s case, however, was not an action brought in state court based on state law claims – the case was based upon federal law (i.e., ’33 Act claims). But surely Congress meant to restrict litigation of those claims to federal court just like cases under the Securities Exchange Act of 1934 (the “’34 Act”) – right?

Well – Section 22 of the ’33 Act provides in part that “[Federal] courts . . . shall have jurisdiction of offenses and violations under [the ’33 Act] . . ., and, concurrent with State . . . courts, except as provided in [SLUSA] section 16 with respect to covered class actions, of all suits . . . brought to enforce any liability or duty created by [the ’33 Act]. Section 16’s State Law Bar provision, however, applies only to state law claims – not to claims created by the ’33 Act. Accordingly, the Supreme Court read the “except” clause essentially as a nullity, removing nothing from state court jurisdiction except the ability to hear class actions based on state law claims – and Beaver County’s case was based on federal claims.

Next considered was Section 22’s non-removal provision, which provides that “[e]xcept as provided in [SLUSA] section 16(c), no case arising under [the ‘33Act] and brought in any State court . . . shall be removed to [federal] court. . . .” Section 16’s Removability Provision was similarly dealt with as it applied (or did not apply) to Beaver County’s case. Because their case was based on federal claims, the Removability Provision simply did not apply – it again was a nullity and did not affect the Section 20’s prohibition on removal from state court of properly filed ‘33 Act cases.

Is this what Congress intended? Great question – but, as the Supreme Court pointed out, Congress knows how to create exclusive jurisdiction as it has done with the ’34 Act. The “except” clauses supposedly meant something to the drafters. The Supreme Court, however, could not ascertain the meaning nor was the Court willing to do more than take Congress at its words (which, interestingly enough were referred to as “gibberish” during oral argument).


[1] The case must allege untrue statements or omission of material facts in connection with the purchase or sale of a covered security; or that the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security.

[2] “Covered securities” for these purposes are certain securities that satisfy certain specified standards for federal preemption of state authority under NSMIA (the National Securities Markets Improvement Act) – i.e., exchange listed securities, securities issued by investment companies).


The Tax Cuts and Jobs Act Evolution

By: George M. Wilson, SEC Institute

As we discussed in our February 2018 program “The Tax Cuts and Jobs Act: Navigating the New Landscape” and our accounting related One-Hour Briefing, “Tax Reform – Getting the Accounting and Disclosure Right!” there is much still to do as we grapple with this complex and intricate new tax law.


Our new program “Tax Cuts and Jobs Act Update 2018: Issues for U.S. Businesses and Individuals” is a great next step in this process. The program will be held on April 19, and while the New York location is sold out the webcast is still available.


As always, your thoughts and comments are welcome!

The Future of Revenue Recognition Fraud?

By: George M. Wilson, SEC Institute

Revenue recognition is an all-time favorite area for cooking a company’s books. For sixteen years Boston-based public company intelligence service Audit Analytics has consistently found revenue recognition near the top of the list in their annual restatement study.


An interesting question many accounting professionals (or geeks as the case may be!) have been wondering is how adoption of the new revenue recognition model in ASC 606 might affect revenue recognition fraud.


No one will know the answer to this question for a while, but a recent SEC enforcement case provides an interesting perspective. In an enforcement action against Maxwell Technologies, the SEC alleges that a former senior sales executive entered into secret side agreements with customers and acted to conceal these agreements from the company’s financial reporting personnel. The SEC also alleges that the former CEO and former CAO did not adequately respond to “red flags” surrounding this activity. All the parties paid fines and the sales executive consented to a five-year officer and director bar.


Software accounting under legacy GAAP was based in large part on contract form. Fraud surrounding contracts, and in particular undisclosed side agreements, was near the list of all-time favorite areas to cook the books under this old GAAP. However, California-based Maxwell manufactures energy storage and power delivery products and is clearly not a software company, but the opportunity to cook the books using contract manipulation still existed.


How does this relate to the new revenue recognition model? As most of us likely know, the first of the five steps in the new model is to identify a company’s contract with a customer. From ASC 605-10-05-4:


  1. Step 1: Identify the contract(s) with a customer—A contractis an agreement between two or more parties that creates enforceable rights and obligations. The guidance in this Topic applies to each contract that has been agreed upon with a customer and meets specified criteria.


In this new GAAP contracts have a significant impact on revenue recognition. Contract terms determine the amount and timing of revenue recognition. Even contract modifications can change the amount and timing of revenue recognition. If it is easy to conceal contract terms it will be easy to manipulate revenue recognition.


The Maxwell case points to the importance of considering the need for new or different kinds of controls over the new revenue recognition process. In the software industry controls over contracts have long been a focus area. For example, many software companies periodically require sales personnel to provide certifications dealing with contract completeness and disclosure of all arrangements with a customer. In the new revenue recognition process these and other kinds of controls may become more relevant for companies outside the software world. In particular, controls over estimates and judgments will become crucial to the reasonableness of revenue recognition. This could be a new challenge in many areas.


Lastly, here is one more cautionary note. As is becoming more and more common in these types of enforcements, there was also a disgorgement by an officer who was not named in the action. Maxwell’s former CFO Kevin Royal, reimbursed the company $135,800 for incentive-based compensation he received while the fraud was being committed.


As always, your thoughts and comments are welcome!

Implementing the New Revenue Recognition Standard – Help is Here!

Reporting professionals are scrambling to get up to speed on the details and how to implement the FASB/IASB New Revenue Recognition Standard.

Learn how to successfully apply and use the new revenue recognition model in ASC 606 to ensure your implementation plan is complete. Also learn how the new standard changes revenue recognition accounting and affects the related estimates and judgements required.

Attend a SECI Revenue Recognition Workshop in May or June and get the answers.

May 1-2         New York

May 21-22    Chicago

June 20-21  San Francisco





The SEC Offers a Few Non-GAAP Tax and RevRec Thoughts

By: George M. Wilson, SEC Institute

While the sound and fury and related wave of comment letters over the use of non-GAAP measures has in large part subsided since the issuance of the May 2016 Compliance and Disclosure Interpretations, the SEC continues to be watchful of how companies use non-GAAP measures.


The 2017 Tax Act and new revenue recognition standard are areas where the staff has indicated they will continue to focus on the use of non-GAAP measures. To be proactive in guiding companies about the use of non-GAAP measures in these areas, at PLI’s “The SEC Speaks in 2018” conference on February 23-24, 2018, speakers from CorpFin leadership discussed their current thinking about the use of non-GAAP for these issues.


Tax Act Considerations


The staff expects that companies will want to use non-GAAP measures to provide more comparable information between periods because of the significant impact enactment of the Tax Act had in 2017, and the impact it can have going forward. The staff’s main concern in this area is “cherry picking.”   If a company presents a non-GAAP measure for the impact of the new Tax Act it should be sure to include all aspects of the Act in that measure. For example, if a company wants to remove the impact of the revaluation of deferred tax assets and liabilities from tax expense for 2017, it should also adjust for all other impacts, such as the tax on repatriation of foreign earnings.


Revenue Recognition Considerations


The staff expects that companies, particularly those that use the modified retrospective method of adoption, will want to use non-GAAP measures to present more comparable information.


One question the staff anticipates is whether or not the analysis in MD&A can use a “full retrospective” approach even if the company formally adopts with the modified retrospective method. The staff indicated that this would be acceptable. However, they cautioned to be careful to include all impacts from the new standard in this approach, such as the impact of contract acquisition and fulfillment costs.


In addition, the staff reminded conference participants that full financial statements on a non-GAAP basis are not appropriate.


The staff also indicated that it could be appropriate, again when using the modified retrospective method of adoption, to present the 2018 compared to 2017 part of MD&A using old GAAP. This would be acceptable, in part because ASU 2014-09 requires companies using this method to present revenue in the year of adoption with information about how much and why the new standard impacts each line of the financial statements. After the year of adoption, however, this approach would not be appropriate in the view of the staff. In addition, companies using this approach in MD&A would have to address the impact of adopting the new standard in the year of adoption.


As always, your thoughts and comments are welcome!

Segments, Segments Everywhere

By: George M. Wilson, SEC Institute

It is almost impossible to attend an SEC workshop or conference and not hear the words “operating segments.” In the IPO process operating segment disclosures are almost always a time consuming and complex issue. The importance of this information to investors coupled with the subjective and complex nature of the related accounting guidance both contribute to this challenge. While this will likely always be a complex issue in our reporting, the FASB has started a project to review certain parts of the related GAAP.


As you can read in this Project Summary, the Board is planning to focus on aggregation criteria and the structure of disclosures by segment. From the Project Summary:


Segment Aggregation Criteria For segment aggregation criteria, the Board decided it could:

  1. Move the reportable segment thresholds to form part of the aggregation guidance, that is, develop a brightline threshold for aggregation.
  2. Remove the aggregation criteria, but retain the practical limit guidance.

Segment Disclosure Requirements  For segment disclosure requirements, three alternatives were considered. The Board could:

  1. Add individual pieces of segment information to the list of requirement disclosures.
  2. Require the disclosures in Topic 280, Segment Reporting, to be reported in a table.
  3. Require a table of regularly reviewed information based on how it relates to the lines in the financial statements.



This plan to address the frequently misunderstood and complex aggregation criteria is particularly good news, as the SEC staff frequently challenges aggregation. Companies frequently aggregate segment information to avoid disclosing granular information that could be used by their competitors. This concern frequently directly conflicts with GAAP disclosure requirements. Here is an example of such a comment that a company that operates hotels received:


  1. We note your disclosure that all of your operating segments meet the aggregation criteria to be grouped as a single reportable segment. Please tell us how you considered the need to aggregate your operating segments into reportable segments by brand or property type. In your response, please explain to us in sufficient detail how you determined all of your operating segments meet the aggregation criteria of ASC Topic 280-10-50-11.

This was the second of two comments in a letter dated April 19, 2017. As you might expect, this type of comment can take a lot of work to respond to and frequently is not resolved in the first round of comments.


The aggregation criteria the staff referred to are from ASC 280-10-50-11:


Aggregation Criteria


Operating segments often exhibit similar long-term financial performance if they have similar economic characteristics. For example, similar long-term average gross margins for two operating segments would be expected if their economic characteristics were similar. Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the objective and basic principles of this Subtopic, if the segments have similar economic characteristics, and if the segments are similar in all of the following areas (see paragraphs 280-10-55-7A through 55-7C and Example 2, Cases A and B [paragraphs 280-10-55-33 through 55-36]):


  • The nature of the products and services
  • The nature of the production processes
  • The type or class of customer for their products and services
  • The methods used to distribute their products or provide their services
  • If applicable, the nature of the regulatory environment, for example, banking, insurance, or public utilities.

A very common misapplication of these criteria is to review the five areas, but not start with the issue of “do these operating segments have similar economic characteristics”.


For the comment above, the company’s response was:


We consider each one of our hotels to be an operating segment meeting the definition set forth in ASC Topic 280; however, no individual hotel is a reportable segment because none meets the quantitative threshold for reportable segments. For purposes of determining reportable segment(s), we aggregate all of the Company’s properties, regardless of brand or property type, because all of our hotels meet the criteria for aggregation set forth in ASC Topic 280-10-50-11.

Specifically, we believe that:

Aggregation is consistent with the objective and basic principles of this subtopic; and,

The properties have the following similar economic characteristics:



    The nature of the products and services,


    The nature of the production processes,


    The type or class of the customer for their products and services, and


    The methods used to distribute their products and services.

All but seven of the 96 hotels in the Company’s portfolio are classified by the lodging industry as upper-upscale and luxury properties and represent over 98% of revenues. Further, as disclosed in the 10-K, no single property represents more than 7% of total revenues. The remaining seven hotels are defined as upscale or midscale and represent less than 2% of revenues and as such do not either individually or in the aggregate approach the quantitative thresholds necessary to qualify as a reportable segment.

All of the properties in the portfolio, regardless of brand or property type, share very similar long-term financial performance and economic characteristics, including the nature of their products, services and production processes and the methods used to distribute their product. The hotels are designed and operated to appeal to similar individuals and group leisure and business customers that travel to upper-upscale and luxury properties. For example, while approximately 64% of total revenues are generated from room revenues, the individual hotels typically include meeting and banquet facilities, a variety of restaurants and lounges, swimming pools, exercise/spa facilities, gift shops, and parking facilities. Importantly, these amenities are either a brand(s) standard and/or customer expectation across all of the upper-upscale and luxury hotels in the portfolio. All of the properties in the portfolio react similarly to economic stimulus such as business investment, changes in GDP and changes in travel patterns. Capital allocation decisions to acquire, enhance, redevelop, or perform renewal and replacement expenditures are determined on a property-by-property basis to appropriately match each hotel within its specific market to seek to improve operating performance and include consideration of local market changes in supply and demand.


The staff asked for more information and you can find the company’s second response letter here. The depth of analysis in this second letter is significantly more than in the first response. And, both the comment and the response demonstrate the complexity of this issue in current GAAP.


As always, your thoughts and comments are welcome.