Category Archives: Uncategorized

Get the Message: SEC Enforcement Case Deals With Evaluating ICFR Weaknesses!

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By sending a clear message through the enforcement process, the SEC has come full circle in their concerns about whether ICFR audits are finding material weaknesses. The staff has said on numerous occasions that they see too many situations where a company identifies a control deficiency but the company’s analysis fails when assessing whether the control deficiency is in fact a material weakness.

Over the last few years the SEC Staff have emphasized their concerns in numerous speeches and other public settings. As they sometimes do when they don’t see companies listening, they have also emphasized this issue through enforcement.

This enforcement is dramatic, involving:

The company

Two company officers

The audit partner

The ICFR consulting firm partner (a surprise here!)

 

This excerpt from a December 2015 speech by Deputy Chief Accountant Brian Croteau summarizes the SEC’s concerns:

Still, given the frequency with which certain ICFR issues are identified in our consultations with registrants, I’d be remiss not to remind management and auditors of the importance of properly identifying and describing the nature of a control deficiency and understanding the complete population of transactions that a control is intended to address in advance of assessing the severity of any identified deficiencies.  Then, once ready to assess the severity of a deficiency, it’s important to remember that there are two components to the definition of a material weakness – likelihood and magnitude.  The evaluation of whether it is reasonably possible that a material misstatement could occur and not be prevented or detected on a timely basis requires careful analysis that contemplates both known errors, if any, as well as potential misstatements for which it is reasonably possible that the misstatements would not be prevented or detected in light of the control deficiency.  This latter part of the evaluation, also referred to as analysis of the so called “could factor,” often requires management to evaluate information that is incremental to that which would be necessary, for example, for a materiality assessment of known errors pursuant to SAB 99. The final conclusions on severity of deficiencies frequently rest on this “could factor” portion of the deficiency evaluation; however, too often this part of the evaluation appears to be an afterthought in a company’s analysis.  Yet consideration of the “could factor” is very important. 

The issue is clear; too often companies are finding a control deficiency but not appropriately evaluating the severity of the issue to determine if it is a material weakness.

In a “classic” example this SEC enforcement involves a company that performed its annual ICFR evaluation and stated in its form 10-K that ICFR was effective at year-end. Then, shortly after that report in their Form 10-K, the company restated its financial statements and disclosed the existence of a material weakness. It is very unlikely that the material weakness arose between the year-end of the Form 10-K and the date of the restatement.

You can read about the enforcement in this press release, which also has links to the SEC Enforcement Orders for the company and the individuals involved:

www.sec.gov/news/pressrelease/2016-48.html

 

The fact that the company and auditor were named is not surprising. What is surprising is that the firm the company retained to provide SOX 404 services, which included assisting “management with the documentation, testing, and evaluation of the company’s ICFR” and no external report, was included in the enforcement.

This is a loud and clear message to all participants in the process! Be thorough and complete in your evaluation of control deficiencies!

If you would like to delve a bit deeper into this issue one of our follow-up posts to this year’s Form 10-K Tune-Up One Hour Briefing focused on ICFR issues, including the issue raised in this enforcement case.

You can read our post at:

seciblog.pli.edu/?p=530

 

As always, your thoughts and comments are welcome and appreciated!

 

An Audit Committee Update

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We (that is Carol and George, your blog authors), frequently post about audit committee issues.  For audit committees that want to perform at the highest level possible, PLI has a great program in June.

 

PLI’s Audit Committees and Financial Reporting 2016: Recent Developments and Current Issues program will be presented June 21, 2016 in NYC.  It will be groupcast in several cities and also available via webcast.  Topics discussed will include current SEC reporting issues, audit committee oversight of the implementation of new accounting standards such as revenue recognition and leases, and PCAOB developments for the audit committee.

 

You can learn more about the detailed agenda and how to register at:

 

www.pli.edu/Content/Seminar/Audit_Committees_and_Financial_Reporting/_/N-4kZ1z11i36?fromsearch=false&ID=259781

 

As always, your thoughts and comments are welcome!

Ever Been to an SEC Event? Mark out April 13 for a webcast!

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In our workshops we sometimes joke (a bit) about how fun it is to listen to a webcast of an SEC meeting. And yes, we do say the same thing about FASB meetings. (Total Geek-Out For Sure!)

These meetings are interesting in that you can observe the process the SEC Commissioners and the FASB follow. The depth of the discussions and their careful consideration of the issues is always fascinating to observe.

These meetings generally do not tell you what might happen in the short-term, but do provide a longer-term glimpse into the directions of policy-making and standard setting.

Disclosure effectiveness is a major longer-term initiative at the SEC right now. On April 13, 2016 the SEC is going to discuss “whether to issue a concept release seeking comment on modernizing certain business and financial disclosure requirements in Regulation S-K.”

As you know, this kind of change is something the SEC staff has wanted to do for years. In addition, provisions of both the JOBS Act and the FAST Act focused on disclosure effectiveness. And here is the logical next step – this meeting will likely help illuminate the future direction of disclosure effectiveness.

 

In addition, this meeting may offer ideas that you can implement now to help make your disclosure more direct and useful to investors.

 

So, perhaps this is the time to listen to one of the meetings? You could play it on your computer, have the sound coming out of your speakers, and think how many of your colleagues would join you and listen! SEC Party time perhaps? If you can’t make the live webcast, you can find all of the archived meetings at http://www.sec.gov/news/openmeetings.shtml

 

You can learn more at:

sec.gov/news/openmeetings/2016/ssamtg033016.htm

 

where the original meeting was announced and at:

www.sec.gov/news/openmeetings/2016/ssamtg041316.htm

where the date was changed from March 30 to April 13, 2016.

 

As always, your thoughts and comments are welcome!

Debt Versus Equity – More on Ratchets

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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:

www.buzzfeed.com/williamalden/square-valued-at-29-billion-in-ipo-short-of-expectations?utm_medium=email&utm_campaign=News+-+1119+Thursday&utm_content=News+-+1119+Thursday+CID_8ba44ca9bcced29cacc07f7e086f01c4&utm_source=BuzzFeed%20Newsletters&utm_term=.uxrLvq8pj#.amezg5KWJ
Here is a WSJ article where the WSJ somehow wanted to call this ratchet a “penalty”:

blogs.wsj.com/digits/2015/11/18/square-pays-93-million-penalty-to-some-investors-in-ipo/

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.

www.pli.edu/Content/Debt_vs_Equity_Accounting_for_Complex_Financial/_/N-1z11c8lZ4k?ID=262917

Audit Fee Disclosures –A Few Common Problem Areas in This Independence Disclosure

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Over the last few weeks we have been blogging about auditor independence issues, a very “hot topic” in the current SEC reporting and enforcement environments. One disclosure focused on independence, audit fees, has been around for over 15 years. You would think that after 15 years it would be routine and perhaps even “ho hum”. However, like so many detailed disclosures, it has complexities that create questions and problems. Here are three examples:

In the disclosure where should fees related to 33 Act services such as comfort letters be included? Are these Audit Fees or Audit-Related Fees?

The Audit Fee disclosure uses the terminology “fees billed”. What is the appropriate treatment if the auditor has not fully billed for the audit?

Where should benefit plan audit fees be presented? Audit Fees or Audit-Related Fees?

We’ll answer these questions below, but first, lets briefly review how this disclosure sheds light on auditor independence. Investors can use this information to compare the magnitude of audit fees with non-audit fees. The key underlying question is “Could the amount of non-audit fees compared to audit fees in any way call into question or compromise auditor objectivity and independence?”

(In this post we won’t go into all the history of this disclosure. If you want to delve into the controversy and issues behind it google search “Enron audit fees.”)

It was a 2003 update to this disclosure that built the requirement with the four categories and two year format we use today. The current requirement, which is in Item 14 of Form 10-K and Schedule 14A for the proxy is:

(1) Disclose, under the caption Audit Fees, the aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the registrant’s annual financial statements and review of financial statements included in the registrant’s Form 10-Q (17 CFR 249.308a) or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years.

(2) Disclose, under the caption Audit-Related Fees, the aggregate fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit or review of the registrant’s financial statements and are not reported under Item 9(e)(1) of Schedule 14A. Registrants shall describe the nature of the services comprising the fees disclosed under this category.

(3) Disclose, under the caption Tax Fees, the aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning. Registrants shall describe the nature of the services comprising the fees disclosed under this category.

(4) Disclose, under the caption All Other Fees, the aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant, other than the services reported in Items 9(e)(1) through 9(e)(3) of Schedule 14A. Registrants shall describe the nature of the services comprising the fees disclosed under this category.

1933 Act Related Fees

These categories seem fairly self-explanatory, but at times can be confusing. For the question about where should fees related to 1933 Act services, including fees for services like comfort letters, be disclosed, you actually have to dig all the way back into commentary in the Final Rule Release. (While we don’t have to do this very often, it is always good to remember this step in the research process!)

While we might be tempted to think of them as “Audit Related”, these 33 Act fees are “Audit Fees”. The Final Rule states:

While the rules we are adopting continue to require issuers to disclose fees paid to the principal accountant for audit services, we are expanding the types of fees that should be included in this category to include fees for services that normally would be provided by the accountant in connection with statutory and regulatory filings or engagements. In addition to including fees for services necessary to perform an audit or review in accordance with GAAS, this category also may include services that generally only the independent accountant reasonably can provide, such as comfort letters, statutory audits, attest services, consents and assistance with and review of documents filed with the Commission.

To research the Final Rule Release you can find it at:

www.sec.gov/rules/final/33-8183.htm

 

The Terminology “Fees Billed”

In the category audit fees does the word “billed” mean that this should be on an as-billed basis or more accrual basis?

The Office of the Chief Accountant has provided guidance on these and similar questions in an FAQ document. However, that document is not with the Compliance and Disclosure Interpretations. It is at a separate location for information about independence issues. You can find all the independence documents at:

www.sec.gov/info/accountants/independref.shtml

In particular, the FAQ’s that deal with these issues are at:

www.sec.gov/info/accountants/ocafaqaudind080607.htm

These FAQ’s tell us that the amount should be the fee billed or expected to be billed for the audit. The principle of the disclosure is that we want the fees for the audit to compare with other fees, so regardless of when billed, show the cost of the audit:

Question 2 (issued January 16, 2001 revised 2004)

Q: In determining fees that are disclosed pursuant to Items 9(e) (1) – (e) (4) of Schedule 14A, should the disclosure be based on when the service was performed, the period to which the service applies, or when the bill for the service is received?

A: Fees to be disclosed in response to Item 9(e)(1) of Schedule 14A should be those billed or expected to be billed for the audit of the registrant’s financial statements for the two most recently completed fiscal years and the review of financial statements for any interim periods within those years. If the registrant has not received the bill for such audit services prior to filing with the Commission its definitive proxy statement, then the registrant should ask the auditor for the amount that will be billed for such services, and include that amount in the disclosure. Amounts disclosed pursuant to Items 9(e) (2) – (e) (4) should include amounts billed for services that were rendered during the most recent fiscal year, even if the auditor did not bill the registrant for those services until after year-end.

 

Benefit Plan Audits

And last, for benefit plan audits, the FAQ’s mentioned above state that these fees are “Audit Related”:

Question 7 (issued August 13, 2003)

Q: What fee disclosure category is appropriate for professional fees in connection with an audit of the financial statements of a carve-out entity in anticipation of a subsequent divestiture?

A: The release establishes a new category, “Audit-Related Fees,” which enables registrants to present the audit fee relationship with the principal accountant in a more transparent fashion. In general, “Audit-Related Fees” are assurance and related services (e.g., due diligence services) that traditionally are performed by the independent accountant. More specifically, these services would include, among others: employee benefit plan audits, due diligence related to mergers and acquisitions, accounting consultations and audits in connection with acquisitions, internal control reviews, attest services related to financial reporting that are not required by statute or regulation and consultation concerning financial accounting and reporting standards. Fees for the above services would be disclosed under “Audit-Related Fees.”

As usual, your comments and thoughts are welcome!

A Fall Return to Our Comment of the Week (or So) Blog Posts

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Now that summer vacation is over, and we’ve gotten through a very busy September with lots of SECI programs, we are ready to resume our comment of the week blog posts.

One topic in the news, thanks to all the political campaigning underway, is taxes. As the candidates discuss their plans to reform the tax code, we thought it would make sense to explore in a bit more depth Corp Fin’s comments about tax issues. As you likely know this has been a “frequent comment” hot topic for a while.

Here is a first comment, and a frequent theme in comments, international taxes. As you’ll see, the staff frequently asks for more detail about reconciling items. All of this of course to help readers understand the likelihood of such rates being sustainable.

2. We note from your disclosure in Note 9 that there is a significant reconciling item in the effective income tax reconciliation due to differences between foreign and United States statutory rates, which are primarily attributable to your Luxembourg holding company structure and tax rulings received from Luxembourg tax authorities. Please tell us the nature of the items included in the reconciling line item titled “differences between foreign and U.S. statutory rates.” Also, please provide us with the pre-tax income, statutory rate, and effective tax rate in Luxembourg for all periods presented. Additionally, please tell us the nature of the factors that are driving the changes in this line item from year to year, including the nature of any significant tax rulings.

This second comment in the tax arena is about tax benefits, and even mixes international issues along with the recoverability issue. You can almost hear the next comment asking about “positive and negative” evidence.

  1. Please tell us the facts and circumstances associated with the extraterritorial income tax benefit recognized in each of 2014 and 2013, including the basis for the amount recognized and changes therein. Also, tell us the nature of the reserve applied against such benefits and the amount of the reserve for each year.

Notice how this comment combines domestic versus foreign tax issues along with the theme of disaggregation:

  1. Please revise to disclose the components of income before income taxes as either domestic or foreign. See guidance in Rule 4-08(h) of Regulation S-X. Also, we note that in your reconciliation between the federal statutory rate and the effective income tax rate disclosed in Note L, foreign and state income taxes are combined in one line item. Please note that if either of these items (foreign income taxes or state income taxes) affect the statutory tax rate by more than 5% (either positively or negatively) they should be separately presented on the reconciliation.

And, in this last comment, the significant question of the repatriating the earnings of foreign operations is murky and the staff asks for clarification in disclosure.

  1. You disclose in note 15 that the income tax provision in fiscal 2014 includes $33.7 million of U.S. income and applicable foreign withholding taxes on dividends of $473.7 million due to repatriating foreign subsidiaries earnings to the U.S. parent entity to fund the share repurchase program. You also disclose you have not provided for U.S. and foreign withholding taxes on $471 million of accumulated undistributed earnings of foreign subsidiaries at February 1, 2015 because you intend to reinvest these earnings for the foreseeable future. It is not clear from your present disclosures how management overcame the presumption that all undistributed earnings of subsidiaries will be transferred to the parent and therefore require the accrual of an income tax payable as outlined in ASC 740-30-25-3. Please tell us how you have determined that you have both the ability and intent to indefinitely prevent accumulated undistributed foreign earnings from being repatriated without tax consequences. See ASC 740-30-25-17 and 25-18. In doing so, tell us the following:
    • Explain the specific evidence (e.g. experience of the entity, definite future plans and past remittances, etc.) to substantiate the parent’s assertion of the indefinite postponement of remittances from foreign subsidiaries;
    • Identify the entities and periods where the parent claims permanent reinvestment;
    • Tell us why you have not disclosed that the remittance of undistributed earnings is postponed indefinitely as opposed to the foreseeable future, which is the point used in ASC 740-30-25-19 to describe when it is apparent that a temporary difference reverses and a deferred tax liability is required to be recognized; and
    • Tell us how your decision to repatriate the $473.7 million of funds during 2014 in order to fund your share repurchase program was considered as part of your determination that the $471 million of accumulated undistributed earnings of foreign subsidiaries referenced above continue to be permanently reinvested as of February 1, 2015.

 

Taxes! Well, for now, we will forgo any jokes about how inevitable they are. We do know that tax comments asking for more clarity in disclosure will continue!

 

As always, your thoughts and comments are welcome!

Audit Committee Evolution – Part Two

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In our post last week we began a series focusing on audit committees. We briefly reviewed the history of audit committee requirements over the past 20 years or so hoping that understanding the past will help us understand what the future might hold. The current discussion about audit committee roles and responsibilities flows from this history. This discussion also has roots in several auditor/client events that have happened over the last several years.

This post discusses some of those recent events, primarily SEC Enforcement cases and related matters as they relate to auditor independence. Hopefully this will help provide context and yield more insight into what the future may hold.

One of the major themes in the SEC’s “Possible Revisions to Audit Committee Disclosures” Concept Release is audit committee oversight of independent auditors. Independence is clearly an important aspect of this oversight. Historically independence has been the auditor’s responsibility. When the SEC and the PCAOB have promulgated independence rules they have been directed primarily to the auditor, not the company or the audit committee.

It may be that it is time for this attitude to evolve and change.

Recent SEC enforcement cases provide several examples where the dividing line between the auditor’s and the company’s responsibility for auditor independence has been very fuzzy. (To be clear, in these cases it would not appear that there were many overt bad-actors who set out to break the rules. So, as you read the examples, ponder who should be in place to know the rules and assure compliance?)

A First Example

Sometimes independence problems are very simple. One of these foundational issues is that the auditor may not assist management in the preparation of financial statements. In fact, Regulation S-X Rule 2.01 states:

(4) Non-audit services. An accountant is not independent if, at any point during the audit and professional engagement period, the accountant provides the following non-audit services to an audit client:

(i) Bookkeeping or other services related to the accounting records or financial statements of the audit client. Any service, unless it is reasonable to conclude that the results of these services will not be subject to audit procedures during an audit of the audit client’s financial statements, including:

(A) Maintaining or preparing the audit client’s accounting records;

(B) Preparing the audit client’s financial statements that are filed with the Commission or that form the basis of financial statements filed with the Commission; or

(C) Preparing or originating source data underlying the audit client’s financial statements.

The idea here is that the auditor cannot really “audit” something they have prepared. This seems relatively straightforward, but when broker-dealers were first required to have their audits performed using the standards of the PCAOB and became subject to the SEC’s auditing requirements, this requirement was overlooked in a number of cases. Eight of these cases resulted in enforcement against auditors for helping their clients prepare financial statements.

You can read the details of the cases in this press release:

www.sec.gov/News/PressRelease/Detail/PressRelease/1370543608588

Now, as we described above, independence has usually been the bailiwick of the auditor. But, when there is an independence problem the company bears a harsh cost also, possibly even a new audit of the same period(s) by an auditor who is in fact independent. In a time of change such as using the PCAOB’s standards for the first time, would it be unreasonable to expect that the audit committee would be knowledgeable about these standards and as part of their oversight of auditing matters ask if there were any issues concerning compliance with the new standards? Is it possible that a strong audit committee could help avoid these problems?

Really, the deeper issue here is that a strong audit committee needs to monitor the financial reporting and auditing environment for changes and assure that management deals with these changes. Easy examples in today’s world include cybersecurity and oil prices.

As a postscript to this first example, the very first enforcement case brought by the PCAOB was over this very issue. It was “way back” in May of 2005. You can read the details at:

pcaobus.org/Enforcement/Decisions/Documents/05-24_Goldstein_and_Morris.pdf

 Second Example

The independence relationship can be very complex to track. Even firms with only a few professionals may not always be aware of all the business activities of all its professionals. For larger firms this can be a huge quality control and compliance challenge. In a recent enforcement a large firm was fined when its consulting affiliate maintained a business relationship with an individual who was a trustee and a board and audit committee member of three funds the firm audited.

Certainly there was a breakdown on the part of the firm in this case, but should the audit committees of the funds have been monitoring for such relationships? This is a complex issue, and the question should be addressed. As you will note in the press release linked below, the adequacy of the fund’s audit committee charter was called into question.

You can read the details of this case at:

www.sec.gov/news/pressrelease/2015-137.html

A Third Example

In this case an audit firm’s affiliate in Washington, DC provided lobbying services to companies that were also audit clients. Such advocacy services are always prohibited by the independence rules. And, again, the firm likely may have a quality control system issue to address tracking the myriad of business relationships in a large professional practice. But again the questions surrounding the client’s responsibility and the role of audit committees need to be addressed. It is not just the auditor who has a consequence in this situation. In a complex commercial world where business can happen so quickly, this issue is even more important.

You can read the details of this case at:

www.sec.gov/News/PressRelease/Detail/PressRelease/1370542298984

Concluding Thoughts

None of these cases are simple, and in each case the fact set behind the case makes it clear there were generally no overt bad-actors who were setting out to break rules. Which brings us back to the question, who is there to make sure that the rules are monitored and that companies comply? Is the audit committee part of that structure? We will see how the situation evolves!

As always, your thoughts and comments are appreciated!

 

 

 

Audit Committee Evolution

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Over the last 15 years the role of the audit committee has been discussed, regulated and disclosed in ever increasing and expanding ways.

(Yes, this was true even longer than 15 years ago, but we will focus on the last 15 years for now! Maybe more history later?)

As you have likely heard, in the last several months the SEC and the PCAOB have both been active in developing the next steps of audit committee evolution. All public companies need to deal with these possible changes, and to do that well it helps to have a perspective on how these changes fit into the longer-term change process.

It was way back in pre-SOX years, actually December 1999, that the SEC enacted rules to require the S-K Item 407 Audit Committee Report and related disclosures. Even in this pre-SOX period the importance of the audit committee was clear. The final rule mentions the “Blue Ribbon Committee” that had been formed to deal with this issue:

“We are adopting new rules and amendments to current rules to improve disclosure relating to the functioning of corporate audit committees and to enhance the reliability and credibility of financial statements of public companies. As more fully described in the Proposing Release, the new rules and amendments are based in large measure on recommendations made by the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (the “Blue Ribbon Committee”)”

The Sarbanes – Oxley Act continued the evolution of the audit committee’s role. SOX’s provisions went well beyond disclosure, actually impacting audit committee member qualifications, structure and function. It enacted provisions dealing with:

  • Independence of audit committee members
  • The audit committee’s responsibility to select and oversee the issuer’s independent accountant
  • Procedures for handling complaints regarding the issuer’s accounting practices (whistleblower provisions)
  • The authority of the audit committee to engage advisors
  • Funding for the independent auditor and any outside advisors engaged by the audit committee

Because SOX’s changes go well beyond disclosures, the SOX requirements were implemented by requiring the exchanges to put the provisions in their listing rules.

The PCAOB has also been involved in this process and Audit Standard 16, Communications with Audit Committees, formalized the content and timing of the auditor’s communications with the audit committee. This requirement became effective for years beginning after December 15, 2012.

That is all history, prelude to the future.

As audit committees strive to hold themselves to best practices looking to the future is crucial.

So, what might the future hold?

PCAOB “Dialogue”

In May of 2015 the PCAOB also issued a document titled “Audit Committee Dialogue” to formalize issues it considered important for audit committee members to be aware of and deal with in the evolving focus on audit quality. You can find the “Dialogue” at the PCAOB’s under the “Information for Audit Committee Members”tab.:

http://pcaobus.org/Information/Pages/AuditCommitteeMembers.aspx

SEC Concept Release

The SEC issued a broad and potentially far-reaching Concept Release in July. It seeks comment on areas including audit committee oversight of the audit process, how the audit committee selects the auditor and the role of the audit committee in selecting and evaluating key audit team personnel. You can find the concept release at:

www.sec.gov/rules/concept/2015/33-9862.pdf

Auditor Independence

A kind of wild-card issue that is evolving with enforcement cases is how the audit committee deals with auditor independence issues. The days when this was an issuer for only the auditor are clearly over!

These are issues that need some deeper discussion! So, our next few posts will focus on the “Dialogue”, the concept release, independence and other issues.

If you have any topics you would like to see included, as always, your thoughts and comments are welcome!

SEC Pay Ratio Final Rule and What to Do?

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 As you doubtless have heard, the SEC, in a split vote, approved the Dodd/Frank mandated “Pay Ratio Rule” on August 5. And yes, there is a lot of politics and a lot of discussion going on about the rule.

Companies will, after the discussion is over, have to deal with all the challenges of actually implementing the rule! To help, we have already scheduled a program, “SEC’s Pay Ratio Rule:  What Companies Need to do to Prepare”, which will be webcast on October 15, 2015. You can get the details about the program at:

www.pli.edu/Content/Seminar/SECs_Pay_Ratio_Rule_What_Companies_Need_to/_/N-4kZ1z11asm?fromsearch=false&ID=263557

As always, your thoughts and comments, even the political ones, are welcome!

The Mystery of Public Float (or, Does Everything have to be Gray?)

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A question that frequently arises in our workshops is how to compute the “public float” number that is used to determine whether a company is a large accelerated, accelerated or non-accelerated filer. This is an important computation as it determines deadlines, SOX external audit requirements and Smaller Reporting Company status. The SEC also sometimes uses it when they phase in new rules. This number is disclosed on the cover page of Form 10-K, and is more formally called “common equity held by non-affiliates”.

While this might at first seem like a nice, simple, mechanical computation, like so many of the issues we deal with in the SEC world, it can get gray!

The whole process starts with this definition from Exchange Act Rule 12b-2:

Accelerated filer and large accelerated filer—

  • Accelerated filer. The term accelerated filer means an issuer after it first meets the following conditions as of the end of its fiscal year:

(i)The issuer had an aggregate worldwide market value of the voting and non-voting common equity held by its non-affiliates of $75 million or more, but less than $700 million, as of the last business day of the issuer’s most recently completed second fiscal quarter;

(ii) The issuer has been subject to the requirements of section 13(a) or 15(d) of the Act (15 U.S.C. 78m or 78o(d)) for a period of at least twelve calendar months;

(iii) The issuer has filed at least one annual report pursuant to section 13(a) or 15(d) of the Act; and

(iv) The issuer is not eligible to use the requirements for smaller reporting companies in part 229 of this chapter for its annual and quarterly reports.

The definition of Large Accelerated filer is exactly the same except the dollar threshold is raised to $700 million. This rule also contains the definition of a smaller reporting company. You can find the complete exchange act rule at:

www.ecfr.gov/cgi-bin/text-idx?SID=8e0ed509ccc65e983f9eca72ceb26753&node=17:4.0.1.1.1&rgn=div5#se17.4.240_112b_62

The same information comes into play on the cover page of Form 10-K, in these familiar sections from the instructions to the form:

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

[] Large accelerated filer                                                                   [] Accelerated filer

[] Non-accelerated filer                                                                     [] Smaller reporting company
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.

So, what we commonly refer to as “public float” is, in the SEC’s guidance, defined as “aggregate market value of the voting and non-voting common equity held by non-affiliates”. To properly compute this number, there are two more definitions we need to deal with, both again from Exchange Act Rule 12b-2:

Affiliate. An “affiliate” of, or a person “affiliated” with, a specified person, is a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the person specified.

Control. The term “control” (including the terms “controlling,” “controlled by” and “under common control with”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.

Now, to the computation! First, we must compute the number of shares “held by non-affiliates”. The logical starting point is total number of shares outstanding. Treasury shares that have not been canceled are clearly held by an “affiliate”, that is the company itself, and are omitted from the calculation. Once the total shares outstanding is computed, the next step is to determine how many of these shares are held by “affiliates”.

Here is where the number can get a bit gray!

The definition of affiliate is clearly subjective. What does it mean, as in the definition above, to be a person who “directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the person specified”?

When the definition of control above, that is control means “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise”, is factored into this determination, it is even more gray!

The categories of people who will fall into the affiliate category would clearly include all the company’s directors, as they “direct or cause the direction of management and policies” for the company. Additionally, executive officers, those officers with a policy or strategy setting role, are also clearly affiliates.

Major shareholders of the company may not fall as clearly into the definition of an affiliate. Generally, if a person owns enough shares, they have an ability to impact on the board and management. They may be able to “direct or cause the direction of management or policies”. In this day of activist shareholders, that is very clear. But there is no simple bright line for this determination. Judgment must be used. And, in very close cases, since this is in essence a legal determination, it may be appropriate to consult with counsel!

So, to get the shares held by non-affiliates, excluding shares held be directors and executive officers is fairly clear, shares held by major shareholders will require some judgment!

The next question is why do we use the price on the last business day of the most recently completed second fiscal quarter? We will leave that question our next post!

As always, your thoughts and comments are welcome!