As we mentioned in our quarterly Newsletter, during the late summer the FASB had decided to defer the implementation date for its CECL, Leases, Hedging and Long Duration Insurance Contracts standards for certain types of entities. On November 15, 2019 the final standard for this change was issued. You can find a press release and links to the final ASU here. The press release includes this table summarizing the changes:
As always, your thoughts and comments of celebration are welcome!
After making changes for mining and oil and gas companies the SEC has proposed changes in the statistical disclosures for banks and bank holding companies. You can read the details of the proposed rule here. The proposal has a 60-day comment period from the date it is published in the Federal Register.
The proposed rule would eliminate Guide 3 (which has been essentially the same for 30 years) and provide new disclosures in Regulation S-K. According to the press release announcing the new rule it will require disclosure about:
Distribution of assets, liabilities and stockholders’ equity, the related interest income and expense, and interest rates and interest differential;
Weighted average yield of investments in debt securities by maturity;
Maturity analysis of the loan portfolio including the amounts that have predetermined interest rates and floating or adjustable interest rates;
An allocation of the allowance for credit losses and certain credit ratios; and
Information about bank deposits including amounts that are uninsured.
As always, your thoughts and comments are welcome!
SEC Reporting this year-end presents several challenges, including:
Form 10-K updates from the SEC’s March 2019 Disclosure Modernization rule,
Implementation of Critical Audit Matters, and
New accounting standards including CECL.
Our 35Th Annual SEC Reporting and FASB Forums in New York and San Francisco (and also via webcast) will provide you all the practical knowledge and useful tools you need to successfully navigate this complexity. You will also earn an hour of regulatory ethics CPE. (Note that some state boards of accountancy do not accept regulatory ethics towards their ethics CPE requirements ). You can find all the details and register here.
As always your thoughts and comments are welcome!
As we move towards the end of the third-quarter and begin preparations for year-end reporting we are presenting a series of blog posts focused on common questions and problems in quarterly and annual reports.
This blog post explores some complexities of Item 9 in Form 10-K and the reporting requirements for auditor changes. To illustrate this point, Workshop Instructors Reed Wilson and Rich Alven, who lead SECI’s Form 10-K In-Depth Workshop and who review each Workshop participant’s Form 10-K as part of their Workshop preparations, noted that many of the participants’ company filings do not use Form 10-K Item 9 properly. In a recent Workshop, two out of five companies who had auditor changes misused Item 9.
Clearly, this is a confusing disclosure requirement!
Overview and Summary
The explanation behind this confusion is long and detailed. To help, here is a summary of how this disclosure requirement works. You will get all the details as you read the rest of this blog post:
The Details
One reason for this confusion is the Item 9 title in Form 10-K: “Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.”
From simply reading this description it might seem that auditor changes and /or disagreements with the former auditor should be reported here.
That is not the case.
Another issue that creates confusion in this area is the articulation of Form 10-K and 8-K. Form 10-K Item 9B can (generally!) be used to report information that would normally be reported on Form 8-K if the deadline for a Form 10-K falls in the period that an 8-K would be required.
However, a change in auditor cannot be reported on Form 10-K Item 9B. Because auditor changes are such an important watch area for the SEC they issued this Compliance and Disclosure Interpretation. Confusingly perhaps, the C&DI is not in the 8-K section, but in the overall General Guidance section:
Section 101. Form 8-K — General Guidance
Question 101.01
Question: If a triggering event specified in one of the items of Form 8-K occurs within four business days before a registrant’s filing of a periodic report, may the registrant disclose the event in its periodic report rather than a separate Form 8-K? If so, under what item of the periodic report should the event be disclosed? Item 5 of Part II of Form 10-Q and Item 9B of Form 10-K appear to be limited to events that were required to be disclosed during the period covered by those reports.
Answer: Yes, a triggering event occurring within four business days before the registrant’s filing of a periodic report may be disclosed in that periodic report, except for filings required to be made under Item 4.01 of Form 8-K, Changes in Registrant’s Certifying Accountant and Item 4.02 of Form 8-K, Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review. The registrant may disclose triggering events, other than Items 4.01 and 4.02 events, on the periodic report under Item 5 of Part II of Form 10-Q or Item 9B of Form 10-K, as applicable. All Item 4.01 and Item 4.02 events must be reported on Form 8-K. Of course, amendments to previously filed Forms 8-K must be filed on a Form 8-K/A. See also Exchange Act Form 8-K Question 106.04 regarding the ability to rely on Item 2.02 of Form 8-K. [April 2, 2008]
So, it is clear that neither Item 9B nor Item 9 in Form 10-K should be used to report auditor changes. All changes in auditors must be reported on Form 8-K because this is such a sensitive issue given the risk of opinion shopping.
So, what exactly is supposed to be reported in Item 9? The S-K reference in Item 9 is to S-K Item 304(b). This part of S-K requires the following disclosures:
(b) If: (1) In connection with a change in accountants subject to paragraph (a) of this Item 304, there was any disagreement of the type described in paragraph (a)(1)(iv) or any reportable event as described in paragraph (a)(1)(v) of this Item;
(2) During the fiscal year in which the change in accountants took place or during the subsequent fiscal year, there have been any transactions or events similar to those which involved such disagreement or reportable event; and
(3) Such transactions or events were material and were accounted for or disclosed in a manner different from that which the former accountants apparently would have concluded was required, the registrant shall state the existence and nature of the disagreement or reportable event and also state the effect on the financial statements if the method had been followed which the former accountants apparently would have concluded was required.
These disclosures need not be made if the method asserted by the former accountants ceases to be generally accepted because of authoritative standards or interpretations subsequently issued.
This disclosure requirement begins to unravel the mystery, but to fully understand Item 9 we need to review exactly what “a change in accountants subject to paragraph (a) of this Item 304” is about, and understand what the disclosures about a “disagreement of the type described in paragraph (a)(1)(iv) or any reportable event as described in paragraph (a)(1)(v) of this Item” are about.
It turns out these are the normal requirements for disclosures about a change in auditors required in Form 8-K. The instructions for Item 4.01 in Form 8-K state:
Item 4.01 Changes in Registrant’s Certifying Accountant.
(a) If an independent accountant who was previously engaged as the principal accountant to audit the registrant’s financial statements, or an independent accountant upon whom the principal accountant expressed reliance in its report regarding a significant subsidiary, resigns (or indicates that it declines to stand for re-appointment after completion of the current audit) or is dismissed, disclose the information required by Item 304(a)(1) of Regulation S-K (17 CFR 229.304(a)(1) of this chapter), including compliance with Item 304(a)(3) of Regulation S-K (17 CFR 229.304(a)(3) of this chapter) .
So, any change in auditors will be covered by S-K Item 304(a). However not all auditor changes will include the disclosures about a “disagreement of the type described in paragraph (a)(1)(iv) or any reportable event as described in paragraph (a)(1)(v) of this Item”.
These disclosures will only be required when there has been an auditor change where there were reportable events or disagreements.
(As a side note, don’t forget that retaining a new auditor also requires an Item 4.01 8-K.)
So, this means that disclosure in Form 10-K Item 9 is only required if there has been an auditor change that was previously reported on Form 8-K and as part of the change the company disclosed disagreements with the auditor or reportable events.
But the decision process does not end here. As the instructions to Item 9 refer to S-K Item 304(b) this item provides that disclosure has to be made when the company’s new auditor agrees with the company’s position and does not make the company account for the transactions or other matters involved in the disagreement the way the former auditors thought was appropriate.
Conclusion and Summary
Given the complexity of this decision process, it is not surprising that this disclosure requirement creates confusion. That said, given the more or less “confessing to opinion shopping” orientation of this disclosure, it is really best to not use Item 9 unless it is really required!
As always, your thoughts and opinions are welcome, and if you know of a particularly interesting auditor change please put it in a comment to this post!
The CorpFin staff has provided two incremental sources of information and guidance dealing with shareholder proposals in the proxy process. On September 6, 2019, CorpFin published an “Announcement Regarding Rule 14a-8 No Action Requests.” In this Announcement, CorpFin staff says:
The staff will continue to actively monitor correspondence and provide informal guidance to companies and proponents as appropriate. In cases where a company seeks to exclude a proposal, the staff will inform the proponent and the company of its position, which may be that the staff concurs, disagrees or declines to state a view, with respect to the company’s asserted basis for exclusion. Starting with the 2019-2020 shareholder proposal season, however, the staff may respond orally instead of in writing to some no-action requests.
The second development is Staff Legal Bulletin 14K issued on October 16, 2019. In the SLB CorpFin states:
The Purpose of this bulletin
This bulletin is part of a continuing effort by the Division to provide guidance on important issues arising under Exchange Act Rule 14a-8. Specifically, this bulletin contains information regarding:
Rule 14a-8 addresses shareholder proposals and paragraph (7) provides one of the ways that a shareholder’s proposal can be excluded by the company from its proxy statement:
(7) Management functions: If the proposal deals with a matter relating to the company’s ordinary business operations
How to interpret this language and how much guidance the SEC staff will provide in this process has been evolving over time, and the announcement and SLB are the latest step in this process. It will likely continue to be a difficult process!
As always, your thoughts and comments are welcome!
As you may have heard, Virgin Galactic, Richard Branson’s space tourism company, began trading on the NYSE on October 28, 2019. There was not a lot of press leading up to this listing as the company did not purse a traditional IPO. The company achieved its NYSE listing by merging with a special purpose acquisition company or “SPAC”. A SPAC is a company that raises capital through an IPO and lists on an exchange with the intention of finding another company to acquire. Virgin Galactic merged with a SPAC named Social Capital Hedosophia Holdings Corp. This interesting transaction is very similar to a reverse merger. In the combination of Virgin Galactic with Social Capital Hedosophia Holdings Corp. the accounting acquirer is Virgin Galactic and the legal acquirer is Social Capital Hedosophia Holdings Corp. This in essence results in a NYSE traded company with the historical financial statements of Virgin Galactic, but with the equity section replaced by that of Social Capital Hedosophia Holdings Corp. If you would like to read more check out this definitive proxy statement.
As always, your thoughts and comments are welcome!
The SEC has made some technical corrections to its March 2019 Final Rule for Disclosure Modernization and Simplification. These corrections were made in an August 6, 2019 Final Rule to make technical corrections to the March 20, 2019 original Final Rule.
First, in several registration statement forms (S-1, S-3, S-4, F-1, F-3, and F-4) the Item 3 section header should now read as:
Item 3. Summary Information and Risk Factors
As of September 5, 2019, versions of these forms on the SEC’s web page still had the now obsolete heading of:
Item 3. Summary Information, Risk Factors and Ratio of Earnings to Fixed Charges.
Second, to address some confusion caused by the original Modernization and Simplification Rule, the August 6 Final Rule made a technical correction to the Electronic Code of Federal Regulations (or “e-CFR”) on-line version of the Exhibit Table in S-K Item 601(a). The e-CFR version of the Exhibit Table was updated to make it clear that the new Exhibit 4 “Description of Registrants Securities” is required in Form 10-K. (This is the information in S-K Item 202.) There was a similar update for Exhibit 104 “Cover Page Interactive Data” to clarify that it is required for Forms 10-K and 10-Q as well as Form 8-K.
You can review a few other detailed changes, primarily to the “N” forms, in the Final Rule.
As always, your thoughts and comments are welcome!
It is always a good to remember that auditor independence is not just an issue for auditors but also for audit committees and management. With the recent auditor independence enforcement actions against RSM and PwC as reminders, all companies, and in particular multinational companies, should review their own processes to assure no company personnel act in a way which could impact on auditor independence. Particularly, offices outside the United States, where financial and other personnel may not be aware of the more restrictive SEC independence requirements, should be trained about the restrictions in non-audit services and related issues.
As an additional resource in this process, earlier this year the Office of the Chief Accountant updated its auditor independence FAQs, which could be a helpful resource in policy development and training.
As always, your thoughts and comments are welcome!
In our last post we explored the relationship between metrics and nonGAAP measures, and how a metric that is computed with GAAP numbers is not a non-GAAP measure. In this post we explore other important aspect of metrics, including explaining to investors how they relate to financial performance and also relating them to performance.
When companies present metrics, such as “average monthly users,” these measures can look impressive, but in many business models the relationship between the metric and financial performance measures, such as revenue growth or profitability, may not be clear. This leads the CorpFin staff to write comments such as this:
Another important aspect of disclosing metrics, particularly in MD&A, is to discuss the linkage between the metric and financial performance, as these three comments illustrate:
Clarify how the increase in average MAUs, which you attribute primarily to international user growth that monetizes at a relatively low rate, contributed to the increase in revenue. Revise to include the change in international revenues in order to provide context to this statement; and
Revise to quantify the increase in the number of advertisements delivered, as well as the increase in the number of advertisers and the increase in demand from existing advertisers that each contributed to such increase. In this regard, we note that the number of ad impressions and the number of advertisers are among the variables that impact your growth in monetization affecting your performance, based on your discussion on page 61.
Refer to Item 303(a)(3) and Instruction 4 to Item 303(a) of Regulation S-K and Section III.D of SEC Release No. 33-6835.
Results of Operations, page 71
Lastly, if you do use metrics extensively, it is important to remember that MD&A is written through the eyes of management. So it’s important to consider whether to disclose those metrics that are important to management. The SEC made this point in this comment:
Key Metrics, page 57
As always, your thoughts and comments are welcome!
One frequently misunderstood aspect of the SEC’s non-GAAP measure guidance is whether or not certain “operational metrics” such as same-store sales are non-GAAP measures. Here is an example SEC comment that raises this question:
Item 6. Selected Financial Data, page 52
| In your selected financial data and your results of operations discussion for your segments, you present certain amounts, such as “average realized price per metric ton of primary aluminum”, “average cost per dry metric ton of bauxite”, “average cost per metric ton of alumina” and “average cost per metric ton of primary aluminum”. Please disclose the numerators and denominators used to compute each amount and reconcile the numerators to amounts presented in your financial statements. |
Are measures such as “average cost per dry metric ton of bauxite” non-GAAP measures? The comment above leaves this question open. The starting point in researching whether such measures are non-GAAP measures is the definition of a non-GAAP measure in Reg G and S-K Item 10(e). This is the definition from Reg G:
(a)(1) Non-GAAP financial measure. A non-GAAP financial measure is a numerical measure of a registrant’s historical or future financial performance, financial position or cash flows that:
(i) Excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the statement of income, balance sheet or statement of cash flows (or equivalent statements) of the issuer; or
(ii) Includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented.
(2) A non-GAAP financial measure does not include operating and other financial measures and ratios or statistical measures calculated using exclusively one or both of:
(i) Financial measures calculated in accordance with GAAP; and
(ii) Operating measures or other measures that are not non-GAAP financial measures.
(3) A non-GAAP financial measure does not include 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.
(Note: The definitions in Reg G and S-K Item 10(e) are not exactly the same wording, but are substantially identical. You can review the differences with the links above)
For measures such as same-store sales and those in the comment above this definition may not be simple to apply. In particular a measure such as “average cost per dry metric ton of bauxite” does not fit easily into this thought process. This is an example of a situation where it will be important to look past the S-K guidance and dig a bit deeper.
A good first place to start digging is in the Compliance and Disclosure Interpretations or C&DI’s, published by CorpFin. While they are not “authoritative” they are frequently go-to guidance. As you may know, the SEC has provided guidance about the use of non-GAAP measures in several C&DI’s. These C&DI’s include all the May 2016 and subsequent guidance from the staff that created such discussion and change in the registrant community. However, these C&DI’s don’t address issues in the definition of a non-GAAP measure.
So, what is the next research step? This is a great example of how sometimes questions go beyond the actual rules and the related C&DI’s. To resolve some issues, it is necessary to go all the way back to the SEC Release that adopted the related rules. Here is a quote from the adopting release for the SEC’s non-GAAP measure guidance, which implemented the non-GAAP provisions of SOX:
We do not intend the definition of “non-GAAP financial measures” to capture measures of operating performance or statistical measures that fall outside the scope of the definition set forth above. As such, non-GAAP financial measures do not include:
Non-GAAP financial measures do not include financial information that does not have the effect of providing numerical measures that are different from the comparable GAAP measure. Examples of measures to which Regulation G does not apply include the following:
The release also provides these examples:
Examples of ratios and measures that would not be non-GAAP financial measures would include sales per square foot (assuming that the sales figure was calculated in accordance with GAAP) or same store sales (again assuming the sales figures for the stores were calculated in accordance with GAAP).
For the measures in the comment letter above, as long as the financial components of the measures are computed in accordance with GAAP, they are not non-GAAP measures. And, as you can see in this response letter, the company told the SEC they would expand their disclosures and that the disclosures would be based on GAAP numbers. Because of this approach, the non-GAAP measure guidance would not apply.
This is the first step in presenting metrics to investors. There is more, and our next post will address the issue of explaining why the metric provides relevant information to investors.
As always, your thoughts and comments are welcome!