Tag Archives: form 10-k

A Bit of SEC Trivia – Form 10

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During our Workshops we discuss a lot of detailed information, some of which does not come up often in practice. With this in mind, we thought we would start a series of blog posts about some of these “trivia” topics.

The first trivia question is “What is Form 10 all about?”

Turns out Form 10 is a behind the scenes issue in a current news story. On November 1, 2015, HP officially completed the process of splitting itself up into two separate companies:

HP, Inc. (ticker HPQ) which has the legacy HP PC and printer businesses. This company describes itself with these words:

“Our vision is to create technology that makes life better for everyone, everywhere — every person, every organization, and every community around the globe. This motivates us — inspires us — to do what we do. To make what we make. To invent, and to reinvent. To engineer experiences that amaze. We won’t stop pushing ahead, because you won’t stop pushing ahead. You’re reinventing how you work. How you play. How you live. With our technology, you’ll reinvent your world.” (From www.hp.com)

 Hewlett Packard Enterprise (ticker HPE) which has the HP services and corporate hardware businesses uses these words:

Hewlett Packard Enterprise is an industry leading technology company that enables customers to go further, faster. With the industry’s most comprehensive portfolio, spanning the cloud to the data center to workplace applications, Hewlett Packard Enterprise’s technology and services help customers around the world make IT more efficient, more productive and more secure. (From www.hpe.com)

Behind this split is a myriad of fascinating business reasons, which will doubtless become business school cases in the future. What is fun about the transaction for SEC geeks is how it was accomplished in the public company reporting world. HPE was separated out from HP, essentially a “spin-off” transaction. There were a lot of legal steps in the process, but in essence there was no public offering of HPE stock, it was distributed to the existing HP shareholders.

After the spin-off both companies wanted to trade on the NYSE. For HP Inc. this was easy; this is the corporate entity that was already listed, so no big deal. But what about the newly created HPE?

There is no transaction here to register under the 1933 Act, as stock is not being offered or sold to the public; it is being directly distributed to the existing HP shareholders. So there is no S-1 or S-3 or S-4 to file.

This is where the Form 10 comes in. It is a company’s first, and probably only, 1934 Act registration statement, and is the way a company “registers” under the 1934 Act when it trips over the size tests in the 1934 Act, which HPE did when it distributed stock to more than 2,000 persons. As a result, HPE will start the corresponding periodic and current reporting requirements. So the only SEC filing that HPE had to make in connection with the distribution of its stock to the existing HP shareholders was a Form 10.

To simplify a bit, 1934 Act registration is required if a company has a class of equity security held by 2,000 or more persons or 500 persons who are not accredited investors and over $10 million in assets or if the company wants to list on a national security exchange. Of course HPE met the requirements, and so HPE filed a Form 10. (There is of course more complexity to the registration issue, so if you have to deal with it careful research is required!)

Form 10 is a lot like a Form 10-K and you can see HPE’s Form 10 at:

www.sec.gov/Archives/edgar/data/1645590/000119312515338732/0001193125-15-338732-index.htm

In this filing, the Form 10 itself is a shell, and you will find all the relevant information in Exhibit 99.1.

If you have any SEC trivia you would like us to explore, please let Carol or George know, and as always, your thoughts and comments are welcome and appreciated.

One last little trivia note – if you do a ticker search for HP, guess what company has this ticker? Helmerick and Payne, a contract oil and gas drilling company. Who would have guessed?

Comment of the Week – Debt Versus Equity Issues on the Rise?

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The genesis of this post is actually a panel discussion from PLI’s 47th Annual Institute on Securities Regulation. This program is one of our major events in the CLE world. The roster of speakers is amazing, starting with a keynote address from Chair White and featuring so many SEC alums, current staffers and industry professionals that an SEC geek simply can’t resist the program.

Anyway, on the first day of the conference the first panel discussed capital market “health” in the current environment. One of the market developments they discussed was financing rounds companies complete shortly before an IPO. In the current environment more and more late round investors are demanding “price protection”. This “price protection” includes instruments like warrants with adjustable prices (ratchets or down-rounds) and preferred stock with adjustable conversions options.

(The staff does write comments about these kinds of instruments, and we have a few examples below.)

It turns out that sometimes the valuations used for these private placements shortly before an IPO don’t follow through to the valuations in the IPO. So the late round investors ask for price protection so they won’t seem to have overpaid shortly before an IPO. (This dovetails very nicely with the recent discussion in the financial press about how valuations for “unicorn” companies may be overstated in the current tech world.)

This is exactly the kind of price protection that has been common in emerging companies that have been far from the IPO process, and it is these kinds of instruments that have been the cause of so many restatements.

If you have ever attended any of our Midyear, Annual or Mid-Sized and Smaller Company SEC Reporting & FASB Forums you are familiar with the continuously updated list of restatement issues we discuss at those conferences. For the last seven years, the number one cause of restatements by public companies has been debt versus equity accounting. Instruments such as warrants with repricing provisions combined with the convoluted, complex accounting guidance in this area have caused more restatements than any other issue.

Being one of the few accountants in the Institute on Securities Regulation it was fascinating listening to the lawyers discuss these complex instruments. The discussion of disclosures that should surround these complex instruments and their unique features was deep and rich. No one however mentioned the accounting issues that they create, and the risk of restatement that goes along with this accounting complexity.

It was a great reminder that as accounting professionals we need to be on the watch for this issue and when we see it raise the accounting issues and assure they are dealt with effectively. This is one of the times when communication between finance, legal and accounting professionals is crucial.

If you would like to review an example of the accounting these instruments create, one of the participants on the panel was from BOX, a successful IPO which had this exact situation. In their first Form 10-K and their S-1 you can find a derivative liability on their balance sheet and a related fair value adjustment in their income statement related to redeemable preferred stock warrants they issued which were derivatives. You can find their Form 10-K at:

www.boxinvestorrelations.com/sec-filings

And, last, here are a couple of example comments. All of this really emphasizes the need to be aware of this issue and build the skills to recognize the issue and deal with it effectively.

It appears the exchangeable senior notes issued in August 2014 contain redemption features. Provide us your analysis that supports your conclusion that none of the redemption features are required to be bifurcated in accordance with ASC 815-15. Specifically address whether the debt involves a substantial discount in accordance with ASC 815-15-25-40 through [25-43].

We note your disclosure that the 1.25% Notes contain an embedded cash conversion option and that you have determined that this option is a derivative financial instrument that is required to be separated from the notes. Please provide us with the details of your analysis in determining that this conversion option should be accounted for separately as a derivative and refer to the specific accounting literature you relied on.

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

 

SEC Comment of the Week – A Favorite Topic

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It is hard to believe we are already in mid-October, and the fourth quarter of the calendar year is well underway. Many companies will soon start planning for year-end reporting and being aware of “hot button issues” is a key part of this process. To help in this planning process we are going to highlight key planning issues through our blog posts. Here is the first of these issues we think all companies should be thinking about as year-end approaches.

As we have watched comments in recent weeks, one of the areas that continues to be emphasized is the quantification of analysis in MD&A. The roots of this issue are deep. Way back in 1989 one of the examples in FR 36 laid out the framework:

Revenue from sales of single-family homes for 1987 increased 6% from 1986. The increase resulted from a 14% increase in the average sales price per home, partially offset by a 6% decrease in the number of homes delivered. Revenues from sales of single-family homes for 1986 increased 2% from 1985. The average sales price per home in 1986 increased 6%, which was offset by a 4% decrease in the number of homes delivered.

The increase in the average sales prices in 1987 and 1986 is primarily the result of the Company’s increased emphasis on higher priced single-family homes. The decrease in homes delivered in 1987 and 1986 was attributable to a decline in sales in Texas. The significant decline in oil prices and its resulting effect on energy-related business has further impacted the already depressed Texas area housing market and is expected to do so for the foreseeable future. The Company curtailed housing operations during 1987 in certain areas in Texas in response to this change in the housing market. Although the number of homes sold is expected to continue to decline during the current year as a result of this action, this decline is expected to be offset by increases in average sales prices.

You can find the release at:

www.sec.gov/rules/interp/33-6835.htm

 

In 2003 FR 72 emphasized the importance of understanding the causal factors underlying changes:

  1. Focus on Analysis

MD&A requires not only a “discussion” but also an “analysis” of known material trends, events, demands, commitments and uncertainties. MD&A should not be merely a restatement of financial statement information in a narrative form. When a description of known material trends, events, demands, commitments and uncertainties is set forth, companies should consider including, and may be required to include, an analysis explaining the underlying reasons or implications, interrelationships between constituent elements, or the relative significance of those matters.

You can find the release at:

www.sec.gov/rules/interp/33-8350.htm

 

And, here are a few very recent comments where the staff focuses on these requirements in MD&A. (We have added emphasis to highlight key issues.)

As previously requested, please disclose more detail about the underlying material factors contributing to the increases in comparable store sales in both your year-end and interim results discussions, such as any changes in selling prices, volumes or the introduction or discontinuance of popular products that had a significant impact on your revenue. Refer to Item 303(a)(3)(iii) of Regulation S-K. In this regard, your current disclosures such as stating that comparable store sales increase primarily due to “strong deals in electronics, pets and clothing” do not provide enough insight into the underlying factors that drove the increase in comparable store sales that investors can access the likelihood that past results are indicative of future results. To the extent that multiple offsetting factors influenced your comparable store sales, you should discuss the impact of each significant factor. For example, if “strong deals” indicates that you lowered average prices through increased promotional activity, this would appear to decrease revenue; however, these lower prices may have been more than offset by higher volumes of products being sold. In this case, both the decrease in pricing and the increase in volume should be described.

Throughout your discussion of the results of operations, you refer to various factors that have impacted your results without quantifying the impact of each factor. Where a material change is attributed to two or more factors, including any offsetting factors, the contribution of each identified factor should be described in quantified terms. For example, you attribute the decrease in net sales and unit sales for the (Product A) in 2014 as a result of growth in the Greater China and Japan segments offset by declines in all other segments with no quantification. As another example, you attribute the growth in the Americas segment in 2014 as a result of increased net sales of (Products B, C and D), Software and Services offset by a decline in net sales of (Product E and A) and weakness in foreign currencies but you do not quantify the effects of these individual factors. Please explain to us how you considered quantifying the sources of material changes and offsetting factors throughout your discussion. Refer to Item 303(a)(3)(iii) of Regulation S-K and Section III.D of SEC Release No. 33-6835.

(Bloggers note: The release mentioned here is FR 36 quoted above)

We note you attribute the changes in headcount to explain certain changes in your results of operations but the headcount does not appear to be quantified. Please tell us your consideration of quantifying the headcount at the end of each period as a factor to explain the changes for the line items that are impacted. We refer you to Item 303(a)(3)(iii) of Regulation S-K and Section III.D of SEC Release No. 33-6835.

 

As always, your thoughts and comments are welcome!

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!

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!

Hertz has some Hurts!

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A major restatement by Hertz has been in the news in recent weeks, and thanks to two of our community, Bill Story and Eric Braschwitz, for their timely heads up notice about this restatement. Hertz was late with their 2014 10-K, filing it in early July. And it is a major restatement.

The magnitude of the issues, the nature of the organizational issues involved, the impact that leadership had on financial reporting, and all the other issues that seem to be at the root of this restatement are old stories, and somehow seem to harken back to days before SOX. Much has been written about these issues and we won’t rehash them here.

But there is one issue we do want to bring out.

As a preliminary note, if you want to dig into the filings involved, you will find Hertz Global Holdings, which is the publically owned company, and another filer, Hertz, which is the operating company, and is wholly owned by Hertz Global Holdings. You will find the restatement issue in the Form 10-K for each of these businesses.

If you look back at Hertz Global Holdings’ 2013 Form 10-K, you will find this ICFR Report:

ITEM 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures

 (This section is omitted for this blog)

Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act, as amended. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2013. The assessment was based on criteria established in Internal Control—Integrated Framework 1992 issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that our internal control over financial reporting was effective as of December 31, 2013. PricewaterhouseCoopers LLP, our independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting. Their report is included in this Annual Report under the caption “Item 8—Financial Statements and Supplementary Data.”

So, everything looks like “situation normal” at Hertz. Then, for 2014, here is what happened.

From Hertz’ 2014 10-K, Item 9A is really long, so we will put our concluding comments here.

What?

And, note the focus on tone at the top!

As always, your thoughts and comments are welcome!

 

From Hertz’ 2014 Form 10-K

ITEM 9A. CONTROLS AND PROCEDURES

Restatement of Previously Issued Financial Statements

As described in additional detail in the Explanatory Note to this Annual Report on Form 10-K, in June 2014, we commenced an internal investigation of certain matters related to the accounting during prior periods. The investigation was undertaken by outside counsel, along with independent counsel for the Audit Committee. Counsel received assistance from outside consultants and new senior accounting and compliance personnel. The internal investigation is complete, although our outside counsel and the independent counsel to the Audit Committee continue to provide forensic and investigative support in connection with certain proceedings discussed in Item 3, “Legal Proceedings” and in Item 8, Note 14, “Contingencies and Off-Balance Sheet Commitments” to the consolidated financial statements in this Annual Report on Form 10-K involving our restatements and related accounting for prior periods.

Based on the internal investigation, our review of our financial records, and other work completed by our management, the Audit Committee has concluded that there were material misstatements in the 2011, 2012 and 2013 consolidated financial statements. Accordingly, our Board and management concluded that our consolidated financial statements for these periods should no longer be relied upon and required restatement. The restated consolidated financial statements for 2012 and 2013 are provided in this Annual Report on Form 10-K. The unaudited restated selected data for 2011 is included in Item 6, “Selected Financial Data” in this Annual Report on Form 10-K.

Evaluation of Disclosure Controls and Procedures

Our senior management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined under Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2014, due to the identification of material weaknesses in our internal control over financial reporting, as further described below, our disclosure controls and procedures were not effective to provide reasonable assurance that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.

Management’s Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f).

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management, including our new Chief Executive Officer and our Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework (2013). Based on this assessment, management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2014 due to the fact that there are material weaknesses in our internal control over financial reporting as discussed below.

Control Environment

The control environment, which is the responsibility of senior management, helps set the tone of the organization (including a commitment towards openness, honesty, integrity, and ethical behavior), influences the control consciousness of its officers and employees, and is an important component affecting how the organization performs financial analysis, accounting, and financial reporting. A proper organizational tone can be promoted through a variety of means, such as policies and codes of ethics, a commitment to hiring competent employees, the manner and content of oral and written communications, and structures that promote and reward openness, strong internal controls, effective governance, and ethical behavior.

As of December 31, 2014, we did not maintain an effective control environment primarily attributable to the following identified material weaknesses:

  • Our investigation found that an inconsistent and sometimes inappropriate tone at the top was present under the then existing senior management that did not in certain instances result in adherence to accounting principles generally accepted in the United States of America (“GAAP”) and Company accounting policies and procedures. In particular, our former Chief Executive Officer’s management style and temperament created a pressurized operating environment at the Company, where challenging targets were set and achieving those targets was a key performance expectation. There was in certain instances an inappropriate emphasis on meeting internal budgets, business plans, and current estimates. Our former Chief Executive Officer further encouraged employees to focus on potential business risks and opportunities, and on potential financial or operating performance gaps, as well as ways of ameliorating potential risks or gaps, including through accounting reviews. This resulted in an environment which in some instances may have led to inappropriate accounting decisions and the failure to disclose information critical to an effective review of transactions and accounting entries, such as certain changes in accounting methodologies, to the appropriate finance and accounting personnel or our Board, Audit Committee, or independent registered public accounting firm
  • We did not have a sufficient complement of personnel with an appropriate level of knowledge, experience, and training commensurate with our financial reporting requirements to ensure proper selection and application of GAAP in certain circumstances.
  • We did not establish clear reporting structures, reporting lines, and decisional authority responsibilities in the organization.We did not design effective controls over the non-fleet procurement process, which was exacerbated by the lack of training of field personnel as part of our Oracle ERP system implementation during 2013.

These material weaknesses in the control environment resulted in certain instances of inappropriate accounting decisions and inappropriate changes in accounting methodology and contributed to the following additional material weaknesses:

  • We did not design and maintain effective controls over certain accounting estimates. Specifically, we did not design and maintain controls over the effective review of the models, assumptions, and data used in developing estimates or changes made to assumptions and data, related to information technology expenditures; reserve estimates associated with allowances for uncollectible amounts receivable for renter obligations related to damaged vehicles; and accrued unbilled revenue.
  • We did not design and maintain effective controls over the review, approval, and documentation related to journal entries.
  • We did not design and maintain effective controls over changes to our policies and procedures over GAAP, as well as the review, approval, and documentation related to the application of GAAP.

Risk Assessment

We did not effectively design controls in response to the risks of material misstatement. This material weakness contributed to the following additional material weaknesses:

  • We did not design effective controls over certain business processes including our period-end financial reporting process. This includes the identification and execution of controls over the preparation, analysis, and review of significant account reconciliations and closing adjustments required to assess the appropriateness of certain account balances at period end.

Information and Communication

As of December 31, 2014, we did not maintain effective controls over information and communications. Specifically, we did not have an adequate process for internally communicating information between the accounting department and other operating departments necessary to support the proper functioning of internal controls. This material weakness led to misstatements in the capitalization and timing of depreciation of non-fleet capital.

Monitoring

We did not design and maintain effective monitoring controls related to the design and operational effectiveness of our internal controls. Specifically, we did not maintain personnel and systems within the internal audit function that were sufficient to ensure the adequate monitoring of control activities. This control deficiency resulted in some instances of the internal audit function’s failure to identify or sufficiently follow through on the analysis of certain inappropriate accounting decisions and changes in accounting methodology.

One or more of the foregoing control deficiencies contributed to the restatement of our financial statements for the years 2012 and 2013 and each of the quarters of 2013, including the misstatements of direct operating expenses, accounts payable, accrued liabilities, allowance for doubtful accounts, prepaid expenses and other assets, and non-fleet property and equipment and the related accumulated depreciation. Additionally, the foregoing control deficiencies could result in material misstatements of the consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that these control deficiencies constitute material weaknesses.

The effectiveness of our internal control over financial reporting as of December 31, 2014 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report, which appears in this Annual Report on Form 10-K.

Other Considerations Impacting our Historical Accounting

Our incorrect accounting was caused by the foregoing control deficiencies along with a complex mix of structural and environmental factors. One of those factors was the tone set and pressures imposed by our former Chief Executive Officer, which were inappropriate in certain instances, and may have been a factor influencing one or more employees to record an accounting entry now determined to be improper. Other factors affecting the overall historic accounting environment and employees included the distraction caused by the multiple, conflicting business initiatives; challenges related to managing complex, inefficient legacy systems; the lack of a sufficient complement of personnel with an appropriate level of knowledge, experience, and training with GAAP; unclear reporting structures, reporting lines, and decisional authority in the organization; and other matters. Taken together, these factors fostered a control environment and other control deficiencies that in some instances enabled inappropriate accounting.

Remediation Plan and Status

We have, and continue to, identify and implement actions to improve the effectiveness of our internal control over financial reporting and disclosure controls and procedures, including plans to enhance our resources and training with respect to financial reporting and disclosure responsibilities and to review such actions with the Audit Committee. Leading this process is our Senior Executive Vice President and Chief Financial Officer, who was hired in December 2013 and is being assisted by our new Chief Accounting Officer, who was hired in May 2014.

During 2014 and 2015, we have hired personnel with the appropriate experience, certification, education, and training for all of the key positions in the financial reporting and accounting function and in some cases have created new positions. Consequently, the employees involved in the accounting and financial reporting functions in which misstatements were identified are no longer involved in the accounting or financial reporting functions. In addition, we have taken, or will take, appropriate remedial actions with respect to certain employees, including termination, reassignments, reprimands, increased supervision, training, and imposition of financial penalties in the form of compensation adjustments.

In addition, we have taken, and continue to take, the actions described below to remediate the identified material weaknesses. As we continue to evaluate and work to improve our internal controls over financial reporting, our senior management may determine to take additional measures to address control deficiencies or determine to modify the remediation efforts described in this section. Until the remediation efforts discussed in this section, including any additional remediation efforts that our senior management identifies as necessary, are completed, the material weaknesses described above will continue to exist.

Control Environment

Our Board has directed senior management to ensure that a proper, consistent tone is communicated throughout the organization, which emphasizes the expectation that previously existing deficiencies will be rectified through implementation of processes and controls to ensure strict compliance with GAAP and regulatory requirements. We also have taken steps to effect a proper tone through changes in our personnel and policies.

On September 7, 2014 our former Chairman and Chief Executive Officer resigned his position. On November 20, 2014, a new President and Chief Executive Officer was named from outside the Company following a national search led by a special committee of the Board, with the assistance of an executive search consultant.

Our new President and Chief Executive Officer is one of four new members of our Board. The three other new directors joined our Board pursuant to the nomination and standstill agreement dated September 15, 2014 between the Company and the Icahn Group, which is included as Exhibit 99.1 to our Form 8-K filed on September 16, 2014.

In addition, since December 2013, we have hired the following additional key employees into the following positions who reflect our standards for integrity and ethical values:

  • Senior Executive Vice President and Chief Financial Officer
  • Senior Executive Vice President, Chief Administrative Officer and General Counsel
  • Senior Executive Vice President and Chief Revenue Officer
  • Executive Vice President and Chief Human Resource Officer
  • Executive Vice President and Chief Information Officer
  • Senior Vice President and Chief Accounting Officer
  • Senior Vice President and Chief Audit Executive
  • Senior Vice President, Procurement, Fleet and Project Management Office
  • Senior Vice President, Financial Planning and Analysis

In addition to the senior management changes detailed above, in order to ensure we have a sufficient complement of personnel with an appropriate level of knowledge, experience, and training commensurate with our financial reporting requirements, during 2014 and 2015 we have hired personnel for all key positions in the financial reporting and accounting function and in some cases have created new positions, including:

  • Senior Vice President and Controller (Corporate Finance)
  • Senior Vice President and Controller (U.S. Rental Car Operations
  • Vice President, SOX Compliance
  • Assistant Controller (Corporate Finance)
  • Vice President, Reporting, Research and PolicyVice President, Financial Systems
  • Vice President, Accounting and Assistant Controller Global Fleet
  • Vice President, Dublin Financial Shared Service Center
  • Senior Director, Oklahoma Financial Shared Service Center
  • Senior Director, Program Accounting
  • Senior Director, Financial Reporting
  • Director, U.S. Rental Operations Finance Consolidation and Analytics
  • Director, Financial Systems
  • Director, Technical Accounting
  • Director, Corporate Accounting
  • Director, Consolidations
  • Director, Policies and Procedures
  • Director, Global Procure to Pay
  • Director, SOX Compliance
  • Director, North America General Accounting

To assist in the restatement activities we augmented our personnel with qualified consulting resources and they will continue to be augmented by the consulting resources for the remainder of 2015.

Further, in 2014, we reinforced the importance of adherence to established internal controls and Company policies and procedures through formal communications, town hall meetings and employee trainings. To communicate a proper ethical tone and corporate culture, Hertz’s intranet website provides information on our philosophy and values. These philosophies and values, in addition to being addressed at personnel meetings, are periodically communicated to our employees via email notifications throughout the year.

In addition, we have established procedures for ensuring clear reporting structures, reporting lines, and decisional authority responsibilities in the organization and have enhanced communications with our operational departments, accounting, Board and Audit Committee.

To address the material weakness over the non-fleet procurement process, we have strengthened processes and controls for manual accruals and journal entries. In addition, we have enhanced an accrual methodology to ensure completeness over our non-fleet procurement liabilities.

To address the lack of training related to the implementation of our Oracle ERP system, in 2014 management engaged consulting resources to assist in the following:

Completed a library of training modules for the Oracle application;Completed a series of live trainings for Oracle users; andImplemented enhanced knowledge management tools and protocols.

Other activities completed in 2014 and 2015 related to the Oracle ERP system include:

  • Established a Financial Information Systems Steering Committee co-chaired by the Chief Accounting Officer and the Chief Information Officer to monitor activities and developments associated with our financial information systems;
  • Established a data governance team to monitor activities associated with the data integrity of our financial information systems;
  • Implemented changes within the Oracle application to enhance the quality of data and the timeliness of processing financial results; and
  • Implemented security rule changes to enhance the quality and timeliness of reported results.

To further enhance the financial close process and address the remediation of this material weakness, our management is currently completing activities associated with our chart of accounts and utilization of Oracle ERP features.

We have taken steps to improve our design and maintenance of effective controls for accounting estimates, including:

  • Where necessary, identified, implemented and documented controls over appropriate accounting methodologies for certain accounts;
  • Held trainings with accounting staff in the first quarter of 2015 to ensure there is a thorough understanding of the underlying methodologies implemented;
  • Established policies and procedures for the approval and implementation of new or modified accounting methodologies;
  • Hired accounting personnel with an appropriate level of knowledge and experience to execute the underlying accounting methodologies; and
  • Established policies and procedures for the review, approval and application of appropriate GAAP for transactions and accounting methodology changes.

In addition, to improve our controls over the processing of manual journal entries, we have reinforced procedures to ensure that manual journal entries recorded in our financial records are properly prepared, supported by adequate documentation, and independently reviewed and approved.

Risk Assessment

We are establishing mechanisms to identify, evaluate, and monitor risks to financial reporting throughout the organization to remediate our material weakness in the risk assessment process and monitoring, as described below.

We have designed and where appropriate enhanced controls over the preparation, analysis and review of transactions and, execution of balance sheet and significant account reconciliations. In addition, we have reinforced existing policies and procedures and enacted policy and procedures changes, where necessary, to better define requirements for effective and timely reconciliations of balance sheet and significant accounts, including independent review. We have also implemented a training program specific to the review and preparation of account reconciliations.

We are updating our global risk assessment. In addition, we have updated our internal audit plan to include internal audit monitoring activities responsive to the issues identified in our internal investigation and review of our financial records.

We have implemented new procedures and enhanced controls governing our internal management-led Disclosure Committee, sub-certification, and external reporting processes associated with the review and approval of the content of our SEC filings and other public disclosures.

Information and Communication

We have formalized procedures to ensure appropriate internal communication between the accounting department and other operating departments necessary to support the proper functioning of internal controls.

In addition, we are in the process of updating the corporate-wide accounting policies manual to ensure proper accounting for transactions in compliance with GAAP and consistently applied across all locations. Additional policies will also need to be developed and issued and corresponding training will need to be provided.

Monitoring

To address deficiencies in our internal audit function, we hired in 2015 a Senior Vice President and Chief Audit Executive, with global responsibilities. In addition, we have commenced recruiting for additional staff members and have recently hired a senior auditor. We are currently supplementing our personnel resources with a substantial number of internal audit consulting resources with financial accounting expertise.

We also have increased the number and quality of personnel assigned to management’s internal controls assessment process. In 2014, we hired a Vice President of SOX Compliance and a Director of SOX Compliance. During 2014 and 2015 we have supplemented our personnel resources with a substantial number of consulting resources experienced in controls and SOX compliance.

During 2014 and 2015, the internal audit and SOX compliance teams enhanced (i) our processes associated with the scoping and identification of processes and key controls, (ii) the documentation of these processes and (iii) our testing procedures to promote the consistency and accuracy of conclusions, deliverables and disclosures associated with SOX compliance. An automated tool is being implemented to monitor these activities.

Changes in Internal Control over Financial Reporting

Our remediation efforts are ongoing. During the quarter ended December 31, 2014, we completed account reconciliation and internal controls trainings for our accounting personnel, created and completed Oracle trainings, enhanced data governance and implemented changes within the Oracle application to enhance the quality of data and the timeliness of processing financial results. There were no other material changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2014 that materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

Disclosure Simplification? That was too easy for GE, they went so much further!

10-K/10-Q Tips, , , , , , , ,

In one of our June workshops a participant brought the most recent GE Form 10-K into the group’s discussions. GE has dramatically redesigned their Form 10-K to be a communication focused document.

If it weren’t for the cover page, most SEC reporting professionals would not even recognize this filing as a 10-K. Right after the cover page is a picture of a GE worker and this is followed by an executive summary. It looks like an annual report to shareholders at first, but no, it is the ACTUAL FORM 10-K! It even has colors!

The document is organized differently to tell GE’s story in a meaningful and engaging way. When you think Form 10-K you usually think of a lock-step structure of Parts and Items, and this structure does not appear at all in this narrative document. GE has used General Instruction C.1. in a very innovative way. This instruction says:

  1. Preparation of Report.
    1. (1)  This form is not to be used as a blank form to be filled in, but only as a guide in the preparation of the report on paper meeting the requirements of Rule 12b-12. Except as provided in General Instruction G, the answers to the items shall be prepared in the manner specified in Rule 12b-13.

GE completely redesigned the structure and the flow. GE did not follow the lock-step format of the Form 10-K Parts and Items. Instead they reorganized the content into a logical structure and flow. In addition, you will see a variety of font sizes and headings, pictures, graphics and other tools to make information easier to follow and understand. (All of course looking back to the concepts of Plain English.)

When we here at the blog first read the document we wondered how it could even be grounded in the Form 10-K instructions, but check out page 231. Here is the linkage to the instructions. In the order of the Parts and Items in the Form 10-K instructions GE cross references to where the required disclosures are in their new 10-K.

The investment in improvement and change in this document is, well, WOW!

You can find the 10-K at:

www.ge.com/ar2014/assets/pdf/GE_2014_Form_10K.pdf

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

10-K Tip – Another S-K Item 201 Oddity

10-K/10-Q Tips, , , , , , , , , , ,

Over the years S-K Item 201 has been amended, updated and added to on several occasions. As a result it has become a bit of a disclosure hodge-podge. It contains more than a few twists and turns, and we explored one of them in our last post about the performance graph from S-K item 201(e) that does not have to be in the Form 10-K.

This post is about another twisty disclosure rule, and is also a reminder that the Compliance and Disclosure Interpretations from CorpFin can be really helpful. You can find them all at:

www.sec.gov/divisions/corpfin/cfguidance.shtml#

This S-K Item 201 twist surrounds the equity compensation table that is required by S-K 201(d). At first reading, you would not think there is even an issue. The instructions to Form 10-K seem clear:

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

(a)  Furnish the information required by Item 201 of Regulation S-K (17 CFR 229.201) and …(rest of the instruction omitted as it is not relevant).

With this straightforward instruction it would seem everything required by S-K Item 201 should be included in Item 5 of the 10-K, including S-K 201(d):

(d) Securities authorized for issuance under equity compensation plans
(1) In the following tabular format, provide the information specified in paragraph (d)(2) of this Item as of the end of the most recently completed fiscal year with respect to compensation plans (including individual compensation arrangements) under which equity securities of the registrant are authorized for issuance, aggregated as follows:

(i) All compensation plans previously approved by security holders; and
(ii) All compensation plans not previously approved by security holders.

However, this seemingly straightforward issue gets disrupted when you get to Item 12 in the Form 10-K instructions which says:

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

Furnish the information required by Item 201(d) of Regulation S-K (§ 229.201(d) of this chapter) and Item 403 of Regulation S-K (§ 229.403 of this chapter).

So, where is the appropriate place in the Form 10-K for this table? For a while many people read the instructions very literally and put the table in both Item 5 and Item 12! Eventually the common sense approach of the SEC, i.e. you don’t really need it twice, was clarified in this Compliance and Disclosure Interpretation:

Regulation S-K: Section 106. Item 201 — Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters

Question 106.01

Question: Is the Item 201(d) disclosure required in Part II of Form 10-K, given that Item 5 of Form 10-K indicates that the registrant is required to furnish the information required under Item 201, or should the Item 201(d) disclosure be included (or incorporated by reference) in Part III of Form 10-K given that Item 12 indicates that the registrant is required to furnish the information required under Item 201(d)?

Answer: The Item 201(d) disclosure should be included in Part III, Item 12 of Form 10-K. An issuer may rely on General Instruction G.3 to Form 10-K to incorporate by reference the Item 201(d) disclosure from its proxy statement or information statement, even if the issuer did not submit a compensation plan for security holder action at its annual meeting of security holders. See American Bar Association (Jan. 30, 2004). [Mar. 13, 2007]

This one is pretty picky, but always good to get the details right! It also shows one facet of the SEC staff’s interpretive process, as the CDI resulted from an interpretive request from the ABA, which is linked to Reg S-K’s CDI 106.1.

As always your thoughts and comments are welcome!

 

Form 10-K Tip – A Subtle Filed Versus Furnished Issue

10-K/10-Q Tips, , , , , , , , , ,

In our previous two posts dealing with the differences between the Form 10-K and the Annual Report to Shareholders (the ARS that accompanies the proxy), we delved into the differences between “filed” and “furnished” documents.

Here is another fairly subtle place that this “filed versus furnished” distinction comes into Form 10-K.

Regulation S-K Item 201(e) is the source of the requirement for the “performance graph” which does a five-year comparison of the return on a $100 investment in the company’s stock, a broad market index and an industry index. (The text of Item 201(e) is included below).

Here is an example of the graph from American Woodmark:

From this part of the Instructions to Item 5 of the Form 10-K it seems relatively straightforward that this graph should be in Item 5 of the 10-K:

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

  1. (a)  Furnish the information required by Item 201 of Regulation S-K (17 CFR 229.201)…

(Note: The rest of the Item 5 instructions are omitted as they do not affect this issue)

However, if you persevere (that is stay awake!) trying to read the whole of S-K Item 201, including the instructions (always an important part of the items!) you will find Instruction 7 to Item 201(e):

  1. The information required by paragraph (e) of this Item need not be provided in any filings other than an annual report to security holders required by Exchange Act Rule 14a-3 (17 CFR 240.14a-3) or Exchange Act Rule 14c-3 (17 CFR 240.14c-3) that precedes or accompanies a registrant’s proxy or information statement relating to an annual meeting of security holders at which directors are to be elected (or special meeting or written consents in lieu of such meeting). Such information will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

The reason for this instruction goes back many years to when changes were made in the proxy rules and this graph was moved from the proxy statement to S-K Item 201.

And, as you read this instruction, you might be tempted to say “so what”! But the subtle and important issue is that the ARS is not a filed document!

So, if you put the graph in the Form 10-K, it is “filed” information, subject to 1934 Act liability provisions. However, if you put it only in the ARS, it is not subject to 1934 Act liability. While this might not be a major issue, it is still one to think about.

One path some companies use is to put the graph on the back page of a 10-K wrap, so it is not actually included in the 10-K itself.

Here is an example of a company, American Woodmark, that dealt with the issue by putting the graph in the 10-K wrap pages instead of the Form 10-K, in order to keep the graph from being filed. Check out page 12 of their ARS:

files.shareholder.com/downloads/AMWD/144697083x0x766550/DAD863ED-7D03-468B-BCCE-E5117F2C1E43/LowRes-14-10531-FSC_AWC-FinalPDF.pdf

Yes, this one is pretty subtle, even picky, but one to think about.

As always, your comments and thoughts are welcome!

Here is the main part text of S-K Item 201(e). You can see the whole Item at:

www.ecfr.gov/cgi-bin/text-idx?SID=8e0ed509ccc65e983f9eca72ceb26753&node=17:3.0.1.1.11&rgn=div5#se17.3.229_1201

S-K Item 201

(e) Performance graph. (1) Provide a line graph comparing the yearly percentage change in the registrant’s cumulative total shareholder return on a class of common stock registered under section 12 of the Exchange Act (as measured by dividing the sum of the cumulative amount of dividends for the measurement period, assuming dividend reinvestment, and the difference between the registrant’s share price at the end and the beginning of the measurement period; by the share price at the beginning of the measurement period) with:

(i) The cumulative total return of a broad equity market index assuming reinvestment of dividends, that includes companies whose equity securities are traded on the same exchange or are of comparable market capitalization; provided, however, that if the registrant is a company within the Standard & Poor’s 500 Stock Index, the registrant must use that index; and

(ii) The cumulative total return, assuming reinvestment of dividends, of:

(A) A published industry or line-of-business index;

(B) Peer issuer(s) selected in good faith. If the registrant does not select its peer issuer(s) on an industry or line-of-business basis, the registrant shall disclose the basis for its selection; or

(C) Issuer(s) with similar market capitalization(s), but only if the registrant does not use a published industry or line-of-business index and does not believe it can reasonably identify a peer group. If the registrant uses this alternative, the graph shall be accompanied by a statement of the reasons for this selection.

10-K Tip of the Week – Annual Report to Shareholders vs Form 10-K

10-K/10-Q Tips, , , , , , , , , , , , ,

In sort of a lighthearted way this week’s Tip is a “versus” tip. With big boxing matches coming up next week, or perhaps just remembering old movies with aliens and monsters, the issue of how the Form 10-K works versus how the Annual Report to Shareholders (ARS) works seems appropriate.

This question frequently comes up in our workshops, and many folks don’t know whether or not the ARS is actually required or where to find the ARS requirements. The ARS is actually a very distinct and separate document from the Form 10-K.

The Form 10-K is the Annual Report to the SEC. It is required by the rules of the SEC and is filed with the SEC. As such, it is not a document furnished directly to shareholders, although they clearly have an opportunity to use the information as it is publicly accessible.

The ARS is actually required by the proxy rules. Rule 14a-3, which deals with information that must be furnished to shareholders in the proxy solicitation process says:

“(b) If the solicitation is made on behalf of the registrant, other than an investment company registered under the Investment Company Act of 1940, and relates to an annual (or special meeting in lieu of the annual) meeting of security holders, or written consent in lieu of such meeting, at which directors are to be elected, each proxy statement furnished pursuant to paragraph (a) of this section shall be accompanied or preceded by an annual report to security holders …….”

When a company is having its annual meeting and will elect directors at this meeting, it must furnish each shareholder with the proxy statement containing information about the election and officers and directors, and also must furnish each shareholder the ARS.

The next logical question is what must be included in the ARS? Rule 14a-3 enumerates the requirements and they include, among lots of other information:

Financial statements
MD&A
Selected financial data

“a brief description of the business done by the registrant and its subsidiaries during the most recent fiscal year which will, in the opinion of management, indicate the general nature and scope of the business of the registrant and its subsidiaries”

For a complete list of all the required information in the ARS check out Rule 14a-3. It is on page 890 of our 2015 SEC Handbook and you can also find it here:

www.ecfr.gov/cgi-bin/text-idx?SID=8e0ed509ccc65e983f9eca72ceb26753&node=17:4.0.1.1.1&rgn=div5#se17.4.240_114a_63

Way back many years ago most companies did a separate ARS which was mailed in paper form to all shareholders along with the proxy statement. To see an example of this kind of traditional ARS check out this one from American Woodmark, a cabinet manufacturer:

files.shareholder.com/downloads/AMWD/107569654x0x673718/998BA1D0-743B-4BEC-A32F-8B7197D3B622/LowRes-13-10246_AWC-2013.pdf

The above link is to the ARS American Woodmark prepared for 2013, and it has wonderful photography and nicely typeset financial statements and MD&A. It is almost elegant in its presentation of information about the company. It is also a very expensive document to produce!

Because this kind of ARS is so expensive, many companies use a more cost effective ARS called the “10-K wrap”. This version of the ARS is actually a cover and perhaps a few pages of financial and company background “wrapped” around the Form 10-K. This approach works well because all the information required by rule 14a-3 that must be furnished to shareholders is in the Form 10-K.

American Woodmark switched to the 10-K wrap approach in 2014. You can find their 2014 ARS at:

files.shareholder.com/downloads/AMWD/107569654x0x766550/DAD863ED-7D03-468B-BCCE-E5117F2C1E43/LowRes-14-10531-FSC_AWC-FinalPDF.pdf

It would be interesting to know how much money American Woodmark saved going from the “pretty picture” ARS to the “10-K wrap” ARS!

To summarize, the Form 10-K is the formal annual report filed with the SEC as part of complying with the 34 Act, while the ARS is not filed with the SEC, it is actually furnished to shareholders.

(The proxy rules do require that copies of the ARS be sent to the SEC, one of the few paper filings companies still have to make.)

Lastly, if you are focusing on the words filed versus furnished in the above sentence, yes, they are very important and mean very different things! We will discuss that difference in our next post!

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