#13101 - The Financial Reporting Process - Securities Regulations (Duke Cox)

An overarching disclosure requirement is that the information the firm releases to the public do more than comply technically with applicable reporting metrics; the report must also “fairly present” its financial position and operations

The supreme authority over accounting standards in the private sector is the Financial Accounting Standards Board (FASB)

The accounting metrics used in preparing the financial statements (GAAP) are objective, not subjective, principles and rules, thereby reducing the opportunity for manipulation of the financial statements by the managers

The SEC requires that financial statements filed with it be certified by an independent auditor; the auditor’s certification attests that the auditor has reviewed the financial statements according to generally accepted auditing standards (GAAS) to assure that the financial statements conform to GAAP

By and large the reporting processes ushered in by the securities laws are either episodic or periodic, and only in special situations can they be seen as even approaching being continuous

1. Periodic: 10-K; 10-Q

   1. The line items that must be disclosed in an issuer’s 10-K and 10-Q are set forth in Regulation S-K

2. Episodic: proxy statement, registration statement

   1. Report is triggered by an event, rather than the calendar

Section 13’s reporting obligation is triggered if the issuer meets one of the following tests (How do we get into reporting requirements?)

1. The security is listed on a national exchange get a listing

2. 12(g): issuers must register a class of equity securities with the SEC if, on the last day of their fiscal year, that class is held of record by 2000 or more persons and the issuer has more than $10 million in assets

   1. JOBS Act:

      1. eliminate from the count shares held by persons who acquired them pursuant to an employee compensation plan

      2. eliminate from the count those who acquired securities through the crowdfunding exemption in 4(a)(6)

      3. imposing Section 12(g) if the issuer’s shares are held by 500 or more unaccredited investors.

3. 15(d) requires an issuer that files a registration statement under the ’33 Act in connection with a public distribution to file periodic reports thereafter. This reporting duty ceases if at the beginning of any fiscal year other than the one in which the registration statement became effective, the securities of each class to which the registration statement related came to be held of record by fewer than 300 persons

§18: private right of action for persons harmed as a result of misleading filing required by the Exchange Act

1. Imposes liability on any person who makes or causes to be made a false or misleading statement in a required filing under the Act and permits recovery of damages by any person “who, in reliance upon such statement, shall have purchased or sold a security at a price which was affected by such statement” unless “the person sued shall prove that he acted in good faith and had no knowledge that such statement was false or misleading”

   1. The plaintiff must actually have relied on the particular misstatement, and the misstatement must have affected the market price of the security

   2. Good faith defense

The opinion letter of the firm’s auditor attests that the audit has been conducted pursuant to generally accepted auditing standards and as a result of such review the auditor has conducted that the financial statements have been prepared according to generally accepted accounting standards and “fairly presents” the firm’s financial position and performance

Simon case: The “fairly presents” language goes beyond the technical requirements of GAAP

1. GAAP will not act as an absolute shield

2. Must still fairly present the financial performance and position of the firm

EA §13(b)(2) requires registered or reporting companies to: (1) make and keep books and records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the issuer; and (2) have in place a system of internal accounting controls sufficient to provide reasonable assurances that (a) transactions are executed only in accordance with management’s authorization, (b) transactions are recorded so as to permit proper accounting and maintain accountability for assets, (c) access to assets is only in accordance with management’s authorization, and (d) recorded accountability for assets is compared with existing assets at reasonable internals, and corrective action taken if appropriate

1. Absolute liability standard not based on materiality; no scienter

World-Wide Coin

1. Internal controls

   1. Inventory storage adequate control over assets

   2. Separation of duties can’t have the same person doing everything

   3. Books and records no formal recordkeeping process here

13b2-1 and 13b2-2 impose upon persons in the corporate hierarchy an obligation to avoid falsification of corporate books and records and require officers and directors to provide accurate information to accountants in connection with preparation of financial statements and reports to the SEC

1. 13(b)(5): prohibition against any person knowingly circumventing or knowingly failing to implement a system of internal controls or knowingly falsifying a book or record thus, liability exposure here is not limited to the registrant alone

404 (SOX)

1. (a): CEO and CFO must certify every quarter their evaluation of internal controls

2. (b): outside auditor must annually assess management’s assessment of internal controls

   1. Because auditors tend to find a lot of things that managers don’t find

   2. Dodd-Frank: will not be subject to 404(b) if market float doesn’t exceed $75 million

      1. But the companies that tend to most need these internal controls/audits are small companies

         1. Big companies tend to be clean

3. Did improve the quality of financial reporting

Audit committees are made up of the company’s directors and have as their central function oversight of the company’s audit and financial reporting practices

1. The NYSE and NASDAQ require that listed companies have audit committees

Audit committee of listed company must be comprised exclusively of “independent” directors

1. Among criteria for being independent is that the director cannot receive any compensation from the issuer other than her director’s fees

2. Audit committee shall be directly responsible for the appointment, compensation, and oversight of auditor’s work in certifying the issuer’s financial statements

3. Must assess risk – including external risk

The SEC rules mandate a dialogue between the auditor and the audit committee on important matters related to the quality of the audited financial reports

The issuer must identify whether its audit committee includes a “financial expert,” and, if not, why such a person is not a member of its audit committee

1. NYSE, NASDAQ, and AMEX require that each audit committee member be financially literate and that the audit committee have a written charter

EA §10A bars auditors from providing certain non-audit services to their audit clients

1. And all services provided to the issuer by the auditor must be approved in advance by the audit committee

2. The over-arching principles underlying its proscriptions of certain types of non-audit services are that an auditor cannot (1) audit his own work, (2) perform management functions, or (3) act as an advocate for the client

3. Bars an accounting firm from auditing the books of any firm whose CEO or CFO in the past year was an employee of the accounting firm

4. 10A(g) requires that the lead audit partner for a client be rotated every 5 years

The CEO and CFO must each certify with respect to each quarterly and annual report that: (1) the officer has reviewed the report; (2) to the certifying officer’s knowledge the report does not contain any untrue statement of material fact; (3) to the certifying officer’s knowledge the report fairly presents in all material respects the financial condition and results of operations of the issuer; (4) the certifying officer is responsible for maintaining the firm’s internal controls and, among other representations, has within the past 90 days evaluated their effectiveness; and (5) the officer has brought to the audit committee’...