On January 21, 2022, CorpFin published a short Announcement, requesting that companies not furnish “courtesy copies” of materials filed or furnished on the EDGAR system, unless the staff requests them.

On December 2, 2021, the SEC adopted rules finalizing implementation of the Holding Foreign Companies Accountable Act (HFCAA).  The HFCAA requires a company to make certain submissions and disclosures if the auditor’s report on the financial statements in its annual report is issued by an auditor located in a foreign jurisdiction where the PCAOB is unable to inspect the auditor’s work.

The Final Rule specifies the SEC’s process to identify affected companies, which are referred to as “Commission-Identified Issuers.”  This process is based on an identification of auditors whose work is not subject to inspection in a related PCAOB Rule.  Identified companies are required to “provide information documenting that they are not owned or controlled by a governmental entity in its public accounting firm’s foreign jurisdiction on or before the due date of their annual report.”

According to the related Fact Sheet, “Commission-Identified Issuers,” that also meet the definition of “foreign issuer” in Rule 3b-4, will be required to make disclosures for itself and other related entities, that include:

•  During the period covered by the form, the registered public accounting firm has prepared an audit report for the issuer;
•  The percentage of the shares of the issuer owned by governmental entities in the foreign jurisdiction in which the issuer is incorporated or otherwise organized;
•  Whether governmental entities in the applicable foreign jurisdiction with respect to that registered public accounting firm have a controlling financial interest with respect to the issuer;
•  The name of each official of the Chinese Communist Party who is a member of the board of directors of the issuer or the operating entity with respect to the issuer; and
• Whether the articles of incorporation of the issuer (or equivalent organizing document) contains any charter of the Chinese Communist Party, including the text of any such charter.

The definition of “foreign issuer” is in Exchange Act Rule 3b-4:

3b-4 Definition of “foreign government,” “foreign issuer” and “foreign private issuer”.

The term foreign issuer means any issuer which is a foreign government, a national of any foreign country or a corporation or other organization incorporated or organized under the laws of any foreign country.

You can read more in this Fact Sheet and the Final Rule.

As always, your thoughts and comments are welcome!

On October 26, 2021, SEC Acting Chief Accountant Paul Munter released a Statement titled “The Importance of High Quality Independent Audits and Effective Audit Committee Oversight to High Quality Financial Reporting to Investors.”  In the Statement, Mr. Munter focuses on the responsibilities of audit committees, management, and of course auditors, in assuring auditors are independent of clients.

He discusses the importance of auditor independence to our capital markets, the shared responsibility for auditor independence, and the importance of gatekeepers in this process, saying:

“The independence of the auditor, in both fact and appearance, is foundational to the credibility of the financial statements.   While sourcing a high quality independent auditor is a key responsibility of the audit committee,  compliance with auditor independence rules is a shared responsibility of the issuer, its audit committee, and the auditor.

As we near the twentieth anniversary of SOX, it is critical for all gatekeepers to continue to vigilantly maintain the independence of auditors, in both fact and appearance. In this regard, auditors and audit clients must carefully consider the scope of their audit and any permissible non-audit engagements that have been pre-approved by the audit committee to guard against impairments of independence. As part of this responsibility, all gatekeepers in the financial reporting ecosystem should be especially mindful of the nature and the scope of any other services provided by the independent auditor.”

The Statement highlights the four guiding principles in Regulation S-X behind the SEC’s auditor independence rules.  Regulation S-X Article 2.01 states:

“In considering this standard, the Commission looks in the first instance to whether a relationship or the provision of a service:

• Creates a mutual or conflicting interest between the accountant and the audit client;
• places the accountant in the position of auditing his or her own work
• results in the accountant acting as management or an employee of the audit client; or
• places the accountant in a position of being an advocate for the audit client.

These factors are general guidance only, and their application may depend on particular facts and circumstances.”

This auditor independence enforcement case involving an audit firm, three of the firm’s partners, and a public company’s former chief accounting officer, illustrates Mr. Munter’s key point that auditor independence is a shared responsibility of companies, audit committees and auditors.  In this case, the audit firm paid a penalty of $10 million, three partners in the firm paid penalties and were barred from SEC practice, and the former chief accounting officer of the company involved paid a fine and was barred from SEC practice.

As always, your thoughts and comments are welcome!

Many MD&A liquidity and capital resources discussions try to explain changes in operating cash flows with opaque explanations, such as “our cash from operating activities decreased because of an increase in accounts receivable.”  Trying to unpack the logic behind this kind of statement to a non-accountant is almost impossible.  It is far more understandable to say, “our cash collections from customers decreased resulting in a decrease in cash flows from operating activities.”  The problem with this more understandable statement, which is essentially based on the direct method of preparing the statement of cash flows, is that reporting systems frequently do not provide the necessary information.

Finding the balance between convoluted statements about how changes in balance sheet accounts affect cash flows and the lack of information necessary to apply the direct method to the statement of cash flows is complex and frequently frustrating.

The SEC challenges companies on this issue when disclosure is unclear.  Here is an example where a company was called upon to clarify these kinds of disclosures in MD&A.

To begin, here is the company’s operating cash flows discussion:

Cash Flows

Operating Activities. Net cash provided by operating activities for the years ended December 31, 2019 and 2018 was $306.3 million and $199.1 million, respectively. Cash provided by operations in 2019 and 2018 resulted from our net income adjusted for non-cash charges for share-based compensation, depreciation and amortization, timing of income tax and employee related payments and changes in other working capital. The significant increase in net cash from operating activities between 2018 and 2019 is primarily due to the higher net income and changes in working capital balances.

This disclosure triggered the following comment from the SEC:

Liquidity, Capital Resources, and Financial Position

Cash Flows

Operating Activities, page 51

Staff Comment:

It appears from the statement of cash flows changes in assets and liabilities, which include working capital items, between 2019 and 2018 of $101.6 million is the substantial cause of the $107.3 million, or 54%, increase in 2019 operating cash flows compared to 2018.  Please revise your disclosure to discuss the material items and the associated underlying factors contributing to the variance.  Refer to IV.B.1 of SEC Release No. 33-8350 for guidance.  Quantify any factors cited, pursuant to section 501.04 of the staff’s Codification of Financial Reporting.  Additionally, define what you consider to be your working capital.

And here is the company’s response, including example new disclosures:

The Company acknowledges the Staff’s comment and will include in its future Annual Reports on Form 10-K enhanced disclosure regarding the matters identified above substantially similar to the following:

Operating Activities.  Net cash provided by operating activities for the years ended December 31, 2019 and 2018 was $306.3 million and $199.1 million, respectively.  Cash provided by operations increased $101.6 million from 2018 to 2019 as a result of changes in the Company’s working capital balances in 2018, resulting from the transaction with GCU.  The Company defines working capital as the assets and liabilities, other than cash, generated through the Company’s primary operating activities.  Changes in these balances are included in the changes in assets and liabilities presented in the consolidated statement of cash flows.  Additionally, for the year ended December 31, 2019 an increase in net income of $30.2 million was partially offset by decreases in non-cash reconciling items of $24.5 million over the prior year period.

Our working capital balances changed primarily due to the transaction with GCU on July 1, 2018, which resulted in operational changes that impacted cash flows of the Company in the second half of 2018.  Commencing July 1, 2018, the Company transitioned to an education services company and no longer has student receivables but records a receivable each month for education services provided to university partners. These changes, along with accrual of interest on the Secured Note receivable from GCU, resulted in a combined $59.3 million reduction in cash inflows from receivables in 2018.    Additionally, in 2018, accounts payable and accrued liabilities associated with our operations prior to the Transaction were settled, resulting in net cash outflows of $30.0 million.

The Company will provide similar disclosures for material fluctuations in operating cash flows in future filings.

As always, your thoughts and comments are welcome!