Financial Reporting


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Financial Reporting

  1. 1. Financial Reporting February 2004 Contents: SEC Year in Review Commission Rulemaking .................3 Audit Committee Financial Expert Disclosures....................3 Significant 2003 Developments Standards for Listed Company Audit Committees.....................3 In 2003, the Securities and Exchange Commission completed Auditor Independence Requirements ............................4 what was probably the busiest period of rulemaking in its his- Internal Control Reporting ........6 tory. The Sarbanes-Oxley Act of 2002 (the Act) required the SEC Improper Influence on Conduct to adopt rules to implement a number of its provisions. In many of Audits ....................................7 Audit Records Retention cases, the time Congress allotted for adopting these rules was Requirements ............................7 short, so implementing the Act dominated the SEC’s rulemaking Code of Ethics Disclosures .........8 Standards of Conduct for agenda in late 2002 and the first half of 2003. However, as the Attorneys....................................8 year progressed, the Commission began addressing a number of MD&A Disclosure – Off-Balance Sheet Arrangements and other important matters, particularly in the areas of improving Contractual Obligations...........8 corporate governance and mutual fund industry reform. The Use of Non-GAAP Financial Measures....................................9 rules the Commission adopted are significant, and implement- Insider Trades During Pension ing them (while at the same time meeting the accelerated Fund Blackout Periods ...........10 Electronic Filing and Website reporting deadlines that begin to affect many issuers this report- Posting of Forms 3, 4 and 5 ..10 ing season) will surely present significant challenges for issuers Equity Securities Purchases by the Issuer ............................10 and their auditors. Director Nomination and Shareholder Communication This letter focuses on rules the Commission adopted in 2003 that are Processes .................................11 aimed at restoring confidence in the financial reporting process and provid- Commission and Staff Guidance ..11 ing more fairness and openness in the activities of those who govern issuers Results of Fortune 500 of securities. Company Report Reviews......11 MD&A Interpretive Guidance ...11 The SEC adopted several rules designed to strengthen the financial reporting and audit- SAB Codification Update ..........11 ing processes: SAB 104 ........................................12 • New SEC and exchange rules are aimed at strengthening the composition For Further Information..................12 of audit committees and their role in the audit process. Companies must
  2. 2. now disclose whether their • New standards of conduct of the filings of the Fortune 500 audit committees include an require attorneys to act when companies and updated its Staff independent financial expert. they become aware of actual or Accounting Bulletins. New listing standards will potential material violations of Although not the focus of this require audit committee mem- laws or breaches of fiduciary letter, it should also be noted that bers to be independent and duty. in 2003 the Commission began require audit committees to be Other rule changes address weaknesses overseeing the activities of the directly responsible for the in reporting and disclosure practices: Public Company Accounting Over- • A company must now provide a sight Board, the new regulator of appointment, compensation, comprehensive explanation of auditors of public companies. In retention, and oversight of the its off-balance sheet arrange- April, the SEC determined that the work of a company’s auditors. ments and an overview of its PCAOB was appropriately organ- • New auditor independence ized and had the capacity to carry requirements enhance audit aggregate contractual obliga- out its duties under the Act. Subse- committees’ ability to fulfill tions. quently, the SEC approved PCAOB their role and change the rela- • Other new rules address abuses rules covering registration of tionship between auditors and related to presenting “pro accounting firms that audit public the companies they audit. forma,” or “non-GAAP,” financial companies. These rules required • In what many believe is the measures. domestic firms to register with the most significant of all the rule- Still other rule changes are designed PCAOB in 2003 and will require for- making driven by the Act, man- to provide more fairness and openness in eign firms to register in 2004. In the activities of those who govern issuers addition, the SEC approved a agement will be required to of securities: PCAOB rule that requires all regis- report annually on the effective- • New Regulation BTR prohibits tered public accounting firms to ness of their company’s internal directors and executive officers adhere to the PCAOB’s auditing controls, and auditors will be from trading company equity and related professional practice required to conduct and report securities during a blackout standards. (While this requirement on the results of an audit of period. is implicit in the Act, this PCAOB those controls. • Insider reports of ownership rule codified that obligation.) The • Rules prohibiting improper changes must now be filed elec- Commission has also approved influence on the conduct of tronically, and issuers with web- PCAOB rules covering its by-laws, audits were adopted to ensure funding, code of ethics, and proce- sites must make them available that management makes open dures for forming advisory groups on or through their websites. and full disclosures to and has to assist it in developing new • In 2004 periodic reports, issuers honest discussions with the standards. will be required to provide dis- company’s auditors. closures about purchases of Looking forward to 2004, the • Other rules were adopted to their equity securities. Commission can be expected to ensure that auditors retain • Beginning with the 2004 proxy continue to focus on mutual fund records that may be relevant to season, issuers must provide a industry reform as well as contro- investigations of financial versial proposals that would number of detailed disclosures reporting improprieties or audit require attorneys to report miscon- regarding the company’s pro- deficiencies. These rules re- duct outside a company and cess for nominating directors quire accounting firms to retain change the director election and the process by which share- records relevant to their audits process by requiring the issuers to holders can communicate with include in their proxy materials the and reviews for seven years. the board. names of candidates nominated by The SEC also adopted rules aimed at This letter also focuses on inter- shareholders. Senior members of restoring confidence in the behavior of cor- pretive guidance the Commission the Commission’s staff have stated porate officers and attorneys: and its staff provided during 2003. that the Commission may take • A company must now disclose The Commission provided impor- action to reform the process by whether it has adopted a code tant interpretive guidance regard- which securities are offered and of ethics for its principal execu- ing preparing Management’s sold under the Securities Act tive and senior financial officers Discussion and Analysis (MD&A). (although on a much less ambi- and, if not, the reasons why not, The Commission’s staff provided a tious scale than the “aircraft car- as well as any changes to or helpful report that discusses com- rier” proposal made in 1998). The waivers of that code. mon issues it noted in its reviews Commission also has rulemaking 2 COPYRIGHT 2004, BDO SEIDMAN, LLP
  3. 3. proposals outstanding that would in its annual report whether or not Nasdaq). Issuers whose securities prescribe disclosure requirements it has at least one audit committee are quoted on interdealer quota- for critical accounting estimates financial expert serving on its audit tion systems, such as the OTC and provide more and faster cur- committee. If so, it must disclose Bulletin Board, the Pink Sheets, rent events reporting by increasing the name of that person and and the Yellow Sheets, are not the number of events to be whether that person is independ- affected. The rules apply to both reported on Form 8-K and acceler- ent. If the company does not have domestic issuers (including small ating the filing deadlines. an audit committee financial business issuers) and foreign This letter summarizes the 2003 expert, it must explain why. issuers. They also apply to invest- Commission and staff activities These new disclosure require- ment companies, although they described above. The Commission ments apply to all issuers, includ- have been tailored to reflect certain publishes rulemaking releases that ing small business issuers and for- unique aspects of investment com- provide background and the text of eign private issuers, other than panies’ organizational structures its rule changes. They are available and safeguards already provided by registered investment companies. on its website ( under (In a separate release, the SEC the Investment Company Act. Regulatory Actions – Final Rule Releases. adopted similar rules for invest- Rule 10A-3 requires an issuer’s The Commission and staff guid- ment companies.) audit committee to meet five stan- ance summarized in this letter is To qualify as an audit commit- dards for the issuer’s securities to also available on the SEC’s web- tee financial expert, a person must be listed: site. The locations are provided have an understanding of GAAP, 1. Independence – Each member of below in the sections in which the financial statements, internal con- the audit committee must guidance is discussed. We previously covered many of trols, and audit committee func- meet independence standards the topics summarized in this letter tions. The person must also be able related to compensation and in the following BDO Seidman to assess the application of GAAP affiliate status. The compensa- Financial Reporting letters: and have experience with the finan- tion standards prohibit a mem- • SEC Meets Sarbanes-Oxley Act cial reporting process. ber from receiving, either Rulemaking Deadline – March These disclosures are required directly or indirectly, any com- 2003 in annual reports for fiscal years pensation from the company • SEC Completes Mandated Sarbanes- ended on or after July 15, 2003 for other than in his or her capacity Oxley Act Rulemaking – July 2003 large issuers and for fiscal years as a member of the board and • SEC Insights – February 2004 ended on or after December 15, its committees. These letters discuss those topics 2003 for small business issuers. A member also must not be in greater detail and are available See our March 2003 Financial an affiliate of the issuer or any on our website ( Reporting letter for further details. of its subsidiaries. Executive about/publications/assurance/). officers, directors who are also References to applicable letters are Standards for Listed employees of an affiliate, gen- provided below. Also available on Company Audit Committees eral partners, and managing our website is our Sarbanes-Oxley (Release 33-8220) members of an affiliate are Act Implementation Reference Guide, In April, the Commission adopted deemed to be affiliates. which outlines the key SEC rule- new Exchange Act Rule 10A-3, 2. Responsibilities Relating to Registered making to implement the Act and which prohibits the national secu- Public Accounting Firms – The provides observations regarding rities exchanges and associations audit committee must be interpreting and implementing from listing the securities of an directly responsible for the those rules. issuer that is not in compliance appointment, compensation, with the Act’s standards for audit retention, and oversight of the committees. This new rule and work of auditors who provide Commission amendments to existing rules also audit services to the issuer Rulemaking affect listed issuers directly by (whether the services are pro- requiring them to make certain dis- vided by the principal auditor or Audit Committee Financial closures. another firm). Expert Disclosures The rules affect issuers whose 3. Procedures for Handling Complaints – (Release 33-8177) securities are listed on a national The audit committee must In January, the SEC adopted rules securities exchange or association establish procedures for the that require a company to disclose (e.g., the NYSE, AMEX, and receipt, retention, and treat- BDO SEIDMAN, LLP, FINANCIAL REPORTING 3
  4. 4. ment of complaints regarding (i) their first annual shareholders • Require auditors to communi- accounting, internal accounting meeting after January 15, 2004, or cate certain matters to audit controls, or auditing matters, (ii) October 31, 2004. Foreign private committees. including procedures for the issuers and small business issuers The rules are also intended to confidential anonymous sub- must comply by July 31, 2005. strengthen auditors’ independence mission by employees of con- See our July 2003 Financial by changing the relationship cerns regarding questionable Reporting letter for further details. between auditors and the compa- accounting or auditing matters. The NYSE, AMEX, and Nasdaq nies they audit. They: 4. Authority to Engage Advisors – The have amended their listing stan- • Prohibit auditors from provid- audit committee must have the dards to comply with the audit ing certain non-audit services authority to engage independ- committee requirements in Rule to their publicly held audit ent counsel and other advisors 10A-3. They have also amended clients; as it determines necessary to their listing standards to enhance • Require greater audit partner carry out its duties. corporate governance practices. In rotation; 5. Funding – The issuer must pro- some respects, the revised listing • Restrict employment of audit vide appropriate funding for the standards are more stringent than team members by a client; and audit committee to compen- the requirements of Rule 10A-3. The • Prohibit accounting firms from sate the outside auditors and SEC’s order approving the compensating audit partners any lawyers and advisors it amended NYSE and Nasdaq listing for selling non-audit services to employs and to fund ordinary standards can be found on the their audit clients. administrative expenses of the SEC’s website ( These changes are quite signifi- audit committee that are neces- 34-48745.htm). The SEC’s order cant because even minor inadver- sary in carrying out its duties. approving the amended AMEX list- tent violations generally cause the Rule 10A-3 contains a number ing standards can be found on the auditor to lose his or her independ- of exemptions and exceptions, AMEX’s website ( in ence. including exceptions to the inde- the News and Events – News Releases The rules also enhance the pendence rules for foreign private section. The NYSE has published a information companies provide issuers to accommodate the differ- frequently asked questions (FAQ) regarding the fees they pay to their ent legal requirements of some for- document covering its rules. This auditors and require them to dis- eign jurisdictions. document is available on the close their audit committees’ prac- Other new rules require certain NYSE’s website ( tices for pre-approving services disclosures. Issuers must include pdfs/section303Afaqs.pdf). provided by their auditors. in their annual reports the names The rules apply to all domestic of each audit committee member. If Auditor Independence and foreign registrants, as well as an issuer does not have a separate Requirements to registered investment compa- audit committee, it must state that (Release 33-8183) nies. They were effective May 6, the entire board of directors is act- In January, the SEC adopted new 2003 but contain certain transition ing as the audit committee. In auditor independence rules that provisions that are discussed addition, an issuer that relies on implement Sections 201, 202, 203, below. certain of the exemptions or excep- 204 and 206 of the Act. Audit Committee Pre-Approval of tions must disclose this fact in its Audit committees play a critical Services – Audit committees must annual report and its proxy materi- role in the financial reporting pre-approve all audit and permit- als covering elections of directors. process and in helping accountants ted non-audit services. An auditor The disclosure must include the maintain their independence from will be deemed to be not inde- issuer’s assessment of whether, audit clients. The new rules are pendent if he or she performs serv- and if so, how, such reliance would intended to enhance audit com- ices without pre-approval. materially adversely affect the abil- mittees’ ability to fulfill that role by The audit committee can either ity of the audit committee to act giving them responsibility for pre-approve a service (1) directly independently and to satisfy the appointing and compensating before the accountant is engaged, other requirements of Rule 10A-3. auditors and overseeing their work. or (2) indirectly via policies and Issuers other than foreign pri- To that end, the new rules: procedures it establishes. Pre- vate issuers and small business • Require audit committees to approval policies and procedures issuers must comply with the new pre-approve all services pro- must be “detailed as to the particu- listing requirements by the earlier of vided by auditors and lar service,” the audit committee 4 COPYRIGHT 2004, BDO SEIDMAN, LLP
  5. 5. must be “informed of each service,” rules. Services that would impair on technical or industry-specific and the policies and procedures an auditor’s independence if he or issues, transactions, or events (e.g., must “not include delegation of the she provided them for a publicly partners assigned to national office audit committee’s responsibilities held audit client include: duties, including technical account- . . . to management.” • Bookkeeping services ing and centralized quality control There is a de minimis exception • Financial information systems functions). There is also an exemp- for permitted non-audit services. design and implementation tion for small firms. The pre-approval requirement is • Appraisal or valuation services The permitted service and waived if the services were not rec- • Actuarial services required time-out periods for the ognized at the time of the engage- • Internal audit outsourcing serv- partners subject to rotation are: ment to be non-audit services and, ices • The lead partner and concurring once recognized, are promptly • Management functions partner are required to rotate brought to the attention of the • Human resources services off the audit after five consecu- audit committee and approved • Broker or dealer, investment tive years of service in either prior to the completion of the advisor, or investment banking role. They must then complete audit. The aggregate amount of all services a five-year time-out period services approved in this manner • Legal services before they can resume provid- may not constitute more than five • Expert services unrelated to the ing services in either of these percent of the total fees paid to the audit roles. auditor during the fiscal year in The rules do not prohibit an • All other audit partners subject which the services are provided. accounting firm from providing tax to rotation are required to The pre-approval requirements services to its audit clients when rotate off the audit after seven apply to all contracts for services those services have been pre- consecutive years of service. entered into after May 6, 2003. approved by the audit committee. They must then complete a Services previously arranged are These prohibitions were effec- two-year time-out period before they can resume providing serv- not subject to the pre-approval tive as of May 6, 2003. For contracts ices to the client. requirements, as long as they are in existence on May 6, 2003, pro- The transition provisions for completed by May 6, 2004. viding previously permitted non- the rotation requirements are as Auditor Communications with Audit audit services will not impair an follows: Committees – An auditor must com- accountant’s independence unless • The rotation requirements municate the following matters to they are still being provided on or applicable to lead partners are the audit committee before the after May 6, 2004. effective for the first fiscal year company files the auditor’s report Audit Partner Rotation Require- that began after May 6, 2003. with the SEC: ments – The new rules expand the Time served as a lead or concur- • All critical accounting policies rotation requirements to all “audit ring partner in prior years is and practices used by the com- partners,” defined as partners on included in determining the pany; the audit engagement team who (1) five-year service period. • All alternative accounting treat- have significant decision-making • The rotation requirements ments within GAAP related to responsibility on auditing, account- applicable to concurring part- material items that have been ing, and reporting matters, or (2) ners are effective for the first fis- discussed with management; maintain regular contact with man- cal year that begins after May 6, and agement and the audit committee. 2004. Time served as a lead or • Other material written commu- The new rules specify that this concurring partner in prior nications between the account- includes (1) the lead audit partner, years is included in determin- ing firm and management. (2) the concurring partner, (3) other ing the five-year service period. These communications must be audit partners who spend more • For lead and concurring part- made prior to the filing of an audi- than ten hours performing audit, ners with foreign accounting tor’s report that is filed on or after review, or attest work at the issuer firms and all other audit part- May 6, 2003. level, and (4) the lead partners on ners, the rules are effective for Services Outside the Scope of Practice subsidiaries whose assets or rev- the first fiscal year that began of Auditors – The Commission enues constitute 20% or more of after May 6, 2003. Time served expanded its list of prohibited serv- consolidated assets or revenues. in prior years does not count ices and eliminated certain excep- The definition specifically excludes toward the maximum service tions provided in the previous partners who provide consultation periods. BDO SEIDMAN, LLP, FINANCIAL REPORTING 5
  6. 6. Employment of Audit Team Members must show fees for each of the two financial reporting in each annual by a Client – A cooling off period is most recent years, rather than the report. They also require a com- now required before a member of previous requirement to disclose pany to engage its auditor to con- the audit engagement team can be information for only the most duct and report on the results of an employed by the client in a “finan- recent fiscal year. Also, companies audit of those controls in each cial reporting oversight role.” A must describe the nature of the annual report. “financial reporting oversight role” services provided for all categories These requirements apply to all is one in which a person is in a except audit fees. issuers, other than registered position to influence the contents A company must also disclose investment companies, that report of a company’s financial state- the audit committee’s policies and pursuant to Section 13(a) or 15(d) ments and related information procedures for pre-approving serv- of the Exchange Act (including (e.g., MD&A) included in its SEC fil- ices to be provided by the auditor. small business issuers and foreign ings. People in such positions Alternatively, companies may pro- private issuers). However, the include but are not limited to vide a copy of those policies and reporting requirements do not members of the board of directors procedures. If the audit committee apply to benefit plans that file on and executive and financial offi- has applied the de minimis excep- Form 11-K. cers. The cooling off requirement tion discussed above, the issuer The management of each issuer does not apply to members of the must disclose the percentage of must evaluate, with the participa- audit engagement team (other total fees paid to the accountant, tion of the issuer’s principal execu- than the lead and concurring part- by category, where the de minimis tive and financial officers, the effec- ners) who provided fewer than ten exception was used. tiveness of the issuer’s internal hours of audit, review, or attest These rules are effective for controls as of the end of each fiscal services. annual reports for fiscal years year. The evaluations must be based on a framework that meets The cooling off period requires ended after December 15, 2003 and specified criteria. The COSO frame- an accounting firm to complete related proxy materials. work will satisfy the criteria. one annual audit subsequent to See our March 2003 Financial However, the rules do not mandate the audit in which an individual Reporting letter for further details. the use of a particular framework. participated before the issuer can In August, the SEC staff pub- A company must maintain evi- hire the individual in a financial lished an FAQ document covering dential matter, including documen- reporting oversight role. There are these rules. This document is avail- tation, to provide reasonable sup- exceptions for employment that able on the SEC’s website port for management’s conclu- results from a business combina- ( sions. Inquiry alone will not provide tion and for individuals employed aqaudind080703.htm). The FAQ ad- an adequate basis for manage- in emergency or unusual circum- dresses 35 questions covering the ment’s assessment. The assess- stances. following topics: ment must be based on procedures Partner Compensation – The new • Partner rotation sufficient to both evaluate the rules prohibit accounting firms • Non-audit services design of the controls and test from compensating audit partners • Audit committee pre-approval their operating effectiveness. Non- for selling non-audit services to requirements management personnel may per- their audit clients. Small firms are • Audit committee communica- form this work. However, manage- exempt from these rules. tions ment must actively supervise the These rules were effective for • Fees disclosures entire process. the first fiscal year of the account- • “Cooling off” period Management must report on ing firm that began after May 6, • Broker-dealers and investment the company’s internal controls in 2003. advisors the annual report. The report must Disclosures Regarding Fees and disclose any material weaknesses Audit Committee Practices – The new Internal Control Reporting in the company’s internal controls, rules increase the categories of (Release 33-3238) and management is not permitted fees that must be disclosed and The Commission adopted new to conclude that the company’s the years covered by the disclo- rules that implement Section 404 internal controls are effective if sure. The categories that must be of the Act in May. These rules there are one or more material disclosed are (a) audit fees, (b) require a company’s management weaknesses. audit-related fees, (c) tax fees, and to evaluate and report on the effec- A company must also file its (d) all other fees. The disclosures tiveness of its internal control over public accounting firm’s report on 6 COPYRIGHT 2004, BDO SEIDMAN, LLP
  7. 7. its audit of the company’s internal above, the Act directed the PCAOB ( controls as part of the annual to establish professional standards 03-017.pdf). report. The attestation cannot be for auditors to follow in performing the subject of a separate engage- this work. Accordingly, the PCAOB Improper Influence on ment. An issuer’s primary auditor has proposed a new auditing stan- Conduct of Audits must issue the attestation report. dard, An Audit of Internal Control Over (Release 34-47890) The effective dates for manage- Financial Reporting Performed in Con- The SEC adopted rules in April that ment reporting and auditor attesta- junction with An Audit of Financial State- implement Section 303 of the Act. tion are as follows: ments. This proposal has been con- Section 303 makes it unlawful for • For accelerated filers – annual troversial for a number of reasons: officers and directors of an issuer, reports for fiscal years ending • Lack of preparer guidance – The and persons under their direction, on or after June 15, 2004. proposed standard requires an to improperly influence the auditor • All other issuers, including for- auditor to express an opinion of the issuer’s financial statements. eign private issuers and small covering a subject matter that is The SEC adopted new Exchange business issuers – annual effectively undefined. This is Act Rules 13b2-2(b) and (c), which reports for fiscal years ending because the preparer commu- prohibit an officer or director of an on or after April 15, 2005. nity lacks effective guidance issuer, or any other person acting In addition, starting with the relating to the extent of docu- under the direction thereof, from first quarter after a company first mentation and testing required directly or indirectly taking any provides the reports discussed to meet its responsibilities. In action to coerce, manipulate, mis- above, management of a domestic the absence of such guidance, lead, or fraudulently influence any issuer must also evaluate whether issuers and auditors must apply auditor performing an audit or any change in the issuer’s internal considerable judgment. As a review of the financial statements controls occurred during each fis- result, practice is likely to be of that issuer if that person knew or cal quarter (including the fourth inconsistent. should have known that such quarter) that has materially • Cost – The proposed standard action, if successful, could result in affected, or is reasonably likely to prescribes a number of proce- rendering such financial state- materially affect, the issuer’s inter- dures an auditor must perform. ments materially misleading. The nal control. Foreign private issuers In many cases, those proce- Commission does not intend to will need to perform this evalua- dures go well beyond the tradi- hold any party accountable for tion on an annual basis. (This tional audit concept of testing honest and reasonable mistakes or requirement should be distin- and examining evidence. to sanction those who actively guished from the requirement to Requiring auditors to perform debate accounting or auditing report significant changes in inter- all of these procedures may issues. nal control over financial reporting unnecessarily raise the cost of The rules took effect June 27, on a quarterly basis if such changes internal control audits. 2003. are identified. The requirement to • Timing – The new standards will See our July 2003 Financial report such changes has been in need to be applied soon (begin- Reporting letter for further details. effect since 2002.) ning with internal control The SEC also made changes to audits of companies with June Audit Records Retention the quarterly evaluation and 2004 year-ends). After the Requirements reporting requirements for disclo- PCAOB revises its proposal to (Release 33-8180) sure controls and procedures, respond to comments, it will In January, the SEC adopted rules revised the wording of the Act’s send it to the SEC for approval. that require accounting firms to Section 302 certifications, and relo- Then the SEC will solicit com- retain records relevant to their cated the Section 302 and 906 cer- ments on the revised proposed audits and reviews for seven years tifications. These certifications standard before approving it. after they conclude an audit or must now be provided as exhibits When a final standard is finally review. to the periodic reports to which issued, there could be little The rules require an auditor to they relate. time for some issuers and their retain records relevant to an audit See our July 2003 Financial auditors to complete all the or review, including (1) workpapers Reporting letter for further details. work it requires. and other documents that form the In addition to mandating the The proposed standard is avail- basis of the audit or review and (2) audits of internal control discussed able on the PCAOB’s website memoranda, correspondence, BDO SEIDMAN, LLP, FINANCIAL REPORTING 7
  8. 8. communications, and other docu- met, a company can disseminate See our March 2003 Financial ments and records (including elec- the required information using its Reporting letter for further details. tronic records) that: website in lieu of filing Form 8-K. • Are created, sent, or received in The Form 8-K reporting require- MD&A Disclosure – Off- connection with the audit or ment does not apply to foreign pri- Balance Sheet Arrangements review and vate issuers, but they must disclose and Contractual Obligations • Contain conclusions, opinions, any such events that occurred dur- (Release 33-8182) analyses, or financial data ing the past fiscal year in their In January, the Commission related to the audit or review. annual reports. amended its MD&A rules to require The new requirements were Code of ethics disclosures are a company to provide: effective October 31, 2003. required in annual reports for fiscal • A comprehensive explanation See our March 2003 Financial years ended on or after July 15, 2003. of its off-balance sheet arrange- Reporting letter for further details. See our March 2003 Financial ments and Reporting letter for further details. • An overview of its aggregate Code of Ethics Disclosures contractual obligations in a tab- (Release 33-8177) Standards of Conduct for ular format. In January, the SEC adopted rules Attorneys These new disclosure require- that require a company to disclose (Release 33-8185) ments apply to all issuers, includ- whether it has adopted a code of The SEC adopted rules in January ing small business issuers and for- ethics for its principal executive that established standards of con- eign private issuers, except that and senior financial officers and, if duct for attorneys. The rules are small business issuers are not not, the reasons why not, as well as intended to protect investors and required to provide the tabular dis- any changes to, or waiver of any increase their confidence in public closure of contractual obligations. provision of, that code of ethics. companies by ensuring that attor- The rules do not apply to registered These new disclosures must be neys who work for those companies investment companies. provided in the annual reports of do not ignore evidence of material These rules are summarized all issuers, including small busi- misconduct. They prescribe mini- below. See our March 2003 Financial ness issuers and foreign private mum standards of professional Reporting letter for further details. issuers, other than registered conduct for attorneys appearing Off-Balance Sheet Arrangements investment companies. (In a sepa- and practicing before the Companies must disclose informa- rate release, the SEC adopted Commission. These standards tion about their off-balance sheet similar rules for investment require attorneys to report actual arrangements in quarterly and companies.) or potential material violations of annual reports and in registration In addition, a company must laws or breaches of fiduciary duty statements. The disclosure must make its code of ethics publicly “up the ladder” within an issuer. be presented in a separately cap- available, and it has three alterna- The rules were effective August tioned section of MD&A. The rules tives for doing so. It may: 5, 2003. follow current MD&A guidelines, • File a copy as an exhibit to its In addition to up the ladder requiring a company to discuss an annual report; reporting, the Commission pro- off-balance sheet arrangement • Post its code on its website (if a posed (but has not adopted) rules only if it is reasonably likely that company chooses this option, it that would require reporting out- the arrangement will have an effect must disclose its website side the company in those rare on the company that is material to address and intent to provide cases where an attorney believes a investors. disclosure in this manner in its violation is occurring and the com- A company must disclose the annual report); or pany has not responded appropri- following, to the extent necessary • Provide an undertaking in its ately. One proposal would require to an understanding of its off- annual report to provide a copy attorneys to make a “noisy with- balance sheet arrangements: of its code to any person with- drawal” through which they would • The nature and business pur- out charge upon request. disaffirm a document or filing pose of the arrangements; A company must also report involving a violation. An alternative • The importance of the arrange- changes to, or waivers of, its code proposal would require the issuer, ments to the company for its of ethics on Form 8-K within five instead of the attorney, to disclose liquidity and capital resources, business days after the event the attorney’s withdrawal to the market risk or credit risk sup- occurred. If certain conditions are Commission. port, or other benefits; 8 COPYRIGHT 2004, BDO SEIDMAN, LLP
  9. 9. • The amounts of revenues, The table must cover both on- They require more extensive expenses, and cash flows aris- and off-balance sheet items. It disclosures than does ing from off-balance sheet must present aggregate amounts Regulation G. They also pro- arrangements; due, by type, for the following types hibit companies from present- • The nature and amounts of any of obligations: ing certain types of non-GAAP interests retained, securities • Long-term debt; measures. These rules are dis- issued, and other indebtedness • Capital lease obligations; cussed further below. incurred in connection with • Operating leases; • Amendments to Form 8-K such arrangements; • Purchase obligations; and require companies to furnish • The nature and amounts of any • Other long-term obligations the text of earnings releases other material obligations or reflected on the balance sheet. and announcements with the liabilities (including contingent Amounts due in less than one SEC, regardless of whether the obligations or liabilities) arising year, one to three years, three to release includes a non-GAAP from such arrangements and five years, and more than five years measure. the triggering events that could must be provided for each category. When a company discloses a cause them to arise; and non-GAAP measure in an SEC fil- Companies should provide foot- • Reasonably likely terminations ing, it must: notes that describe provisions that or material reductions in the • Present, with equal or greater create, increase, or accelerate obli- availability of off-balance sheet prominence, the most directly gations and other information nec- arrangements that provide comparable GAAP measure; essary to understand the timing material benefits to the com- • Quantitatively reconcile the and amount of the obligations cov- pany, and the course of action non-GAAP measure to the most the company will take or plans ered by the table. directly comparable GAAP in response to any such circum- This table is required in regis- measure; stances. tration statements, annual reports, • State the reasons why manage- Generally, the disclosures and proxy materials that are ment believes the non-GAAP should cover the most recent fiscal required to include financial state- measure provides useful infor- year. However, the discussion ments for fiscal years ended on or mation to investors; and should address changes from the after December 15, 2003. • To the extent material, state any previous year where necessary to additional purposes for which an understanding of the disclosure. Use of Non-GAAP Financial management uses the non- These disclosures are required Measures GAAP measure. in registration statements, annual (Release 33-8176) In addition, a company must not: reports, and proxy materials that In January, the SEC adopted rules • Exclude charges or liabilities are required to include financial that address disclosure issues that required or will require statements for fiscal years ended related to “pro forma,” or “non- cash settlement from non- on or after June 15, 2003. GAAP,” financial measures in filings GAAP liquidity measures (EBIT with the SEC and in other public and EBITDA measures are Contractual Obligations disclosures. The Commission excluded from this prohibition); Companies (other than small busi- addressed these issues in three • Eliminate non-recurring, infre- ness issuers) must also provide a table presenting their aggregate ways: quent or unusual items if they contractual obligations. Although • New Regulation G covers pub- are likely to recur within 2 years the table may be presented in any lic disclosures that include or there was a similar item location within MD&A, it is non-GAAP measures, both dis- within the prior 2 years; intended to serve as a focal point of closures that are filed with the • Present non-GAAP measures the liquidity discussion. The table SEC and those that are not. It on the face of or in the notes to should present information as of prohibits using non-GAAP the financial statements; the end of the most recent fiscal measures in a misleading man- • Present non-GAAP measures year. In interim period MD&As, ner and requires companies on the face of Regulation S-X companies should update the that disclose non-GAAP meas- Article 11 pro forma financial information by disclosing material ures to provide specified infor- information; and changes outside the ordinary mation. • Use titles or descriptions that course of business that have taken • Amendments to Regulations are the same as, or confusingly place since the most recent fiscal S-K and S-B and Form 20-F similar to, titles or descriptions year-end. cover disclosures in SEC filings. used for GAAP measures. BDO SEIDMAN, LLP, FINANCIAL REPORTING 9
  10. 10. These rules were effective plans through which participants electronic filing, and website post- March 28, 2003. invest in company equity securi- ing by issuers with corporate web- See our March 2003 Financial ties. During “blackout” periods, sites, of insiders’ beneficial owner- Reporting letter for further details. investors cannot transfer balances ship reports (Section 16 reports, In June, the SEC staff published between investment options. i.e., Forms 3, 4 and 5). This rule- an FAQ document covering these The rules are contained in new making implemented the elec- rules. This document is available on Regulation Blackout Trading tronic filing and website posting the SEC’s website ( Restriction (BTR). Regulation BTR requirements. divisions/corpfin/faqs/nongaapfaq.htm). prohibits directors and executive The website posting rules The FAQ addresses 33 questions officers from trading company require an issuer that maintains a covering the following topics: equity securities during a blackout corporate website to post on that • Transition issues period. It applies to directors and website all Forms 3, 4 and 5 filed • Business combination transac- executive officers of domestic with respect to its equity securities tions issuers, foreign private issuers, by the end of the business day after • Item 10(e) of Regulation S-K small business issuers and, in rare filing. An issuer may satisfy this • EBIT and EBITDA instances, registered investment requirement by providing direct • Segment Information companies. access to the filings or by hyper- • Item 12 of Form 8-K Regulation BTR also requires linking to a third-party website • Foreign Private Issuers companies to notify directors and (such as EDGAR) if certain condi- • Voluntary filers officers of an impending blackout tions are satisfied. In subsequent discussions and period. Domestic companies, in- The rules were effective June 30, speeches, the staff has com- cluding registered investment com- 2003. mented on common problems in panies (who are otherwise exempt Equity Securities Purchases applying the new rules. The issues from Form 8-K filing requirements), by the Issuer the staff seems to mention most must also notify the SEC by filing (Release 33-8335) frequently are: the notice on new Item 11 of Form In October, the Commission • The high disclosure hurdle 8-K. The Form 8-K must be filed on adopted new rules that will require companies must meet to justify the same date the notice is trans- issuers to disclose in Exchange Act presenting non-GAAP meas- mitted to directors and executive periodic reports all repurchases (in ures that exclude recurring officers. Foreign private issuers are open market or private transac- items (for example, when a not required to file Form 8-K but tions) of their equity securities. company presents EBITDA as a must file as an exhibit to their The disclosure requirements apply measure of operating perform- annual reports on Forms 20-F or 40- to domestic issuers, including ance) and F all notices provided to officers small business issuers, foreign pri- • The quality of the disclosures and directors during the year. vate issuers, and registered companies provide to explain Regulation BTR was effective closed-end management invest- why measures are useful to January 26, 2003. The requirement ment companies. investors and how they are to file the notices on Form 8-K was As part of this rulemaking, the used by management (the staff effective March 31, 2003. SEC also amended Exchange Act expects more substantive dis- See our March 2003 Financial Rule 10b-18. That rule offers closures, rather than boiler- Reporting letter for further details. issuers a type of “safe-harbor” pro- plate language). tection against liability for market See our February 2004 Financial Electronic Filing and Website manipulation claims under federal Reporting letter for further details. Posting of Forms 3, 4 and 5 securities laws in connection with (Release 33-8230) repurchases of their securities in Insider Trades During In April, the Commission certain circumstances. The amend- Pension Fund Blackout adopted rules pursuant to Section ments simplify and update the safe Periods 403 of the Act. Effective August 29, harbor provisions to reflect market (Release 34-47225) 2002, Section 403 required insiders developments since that rule was In January, the SEC adopted rules to file reports of ownership adopted. that apply to public companies changes within two business days. Under the new rules, issuers that sponsor individual account Section 403 also mandates the will be required to provide tabular 10 COPYRIGHT 2004, BDO SEIDMAN, LLP
  11. 11. disclosure of information regarding The rules are outlined in Release reports of the Fortune 500 compa- equity securities purchased during 33-8340. They require issuers to nies. In February 2003, the staff each month of the period covered provide a number of specific and published a report that discusses by the report, regardless of whether detailed disclosures regarding the the most common issues ad- the repurchases were effected in company’s process for nominating dressed in those reviews. The staff accordance with Rule 10b-18. The directors and the process by which has informally indicated that these table must provide the following shareholders can communicate issues will likely be the focal points information: with the board. The disclosures are of its reviews of 2003 reports. The • The total number of shares pur- required in proxy materials cover- summary is available on the SEC’s chased; ing elections of directors. In addi- website ( • The average price paid per tion, if there is a process for share- fortune500rep.htm). share; holders to submit director candi- See our February 2004 Financial • The total number of shares pur- dates and there is a material Reporting letter for further details. chased during the month as change in that process, the change part of publicly announced must be reported in the Exchange MD&A Interpretive Guidance share repurchase plans; and Act periodic report (e.g., 10-Q, 10-K) (Release 33-8350) • The maximum number of covering the quarter in which the In December, the Commission shares that may yet be pur- change occurred. The rules apply to issued an interpretive release that chased under share repurchase domestic issuers (including small provides guidance regarding plans. business issuers), and similar dis- preparing MD&A. The Release does The table must also include closure requirements were not create new or modify existing footnotes that provide information adopted for registered investment requirements. Rather, it provides about publicly announced share companies. guidance to help companies pre- repurchase programs and shares The disclosures are required in pare MD&A disclosures that are purchased other than through proxy materials that are first dis- easier for investors to understand share repurchase programs. tributed on or after January 1, 2004 and better satisfy the objectives of The new disclosures will be and in periodic reports for the first MD&A. The Release provides guid- required in Forms 10-Q and 10- reporting period ending after ance regarding: QSB, 10-K and 10-KSB, 20-F, and January 1, 2004. • Improving the overall presenta- N-CSR. The disclosures must first In addition, for the first time in tion and focus of MD&A; appear in domestic issuers’ reports its history, the Commission pro- • Providing meaningful analysis for periods ending on or after posed (but has not adopted) rules as opposed to uninformative March 15, 2004. Foreign private that would change the director discussion; issuers must provide the new dis- election process by requiring the • Quantifying known material closures in reports on Form 20-F issuers referred to above to, in cer- trends and uncertainties; for periods ending on or after tain circumstances, include in their • Using key performance indica- December 15, 2004. Registered proxy materials the names of tors; closed-end management invest- shareholder nominees for election • Improving liquidity and capital ment companies must provide the disclosure in Form N-CSR as a director. These proposed rules resources disclosure; and with respect to any repurchases are outlined in Release 34-48626. • Providing more insightful criti- during any calendar month follow- This proposal is controversial, and cal accounting estimates dis- ing June 2004. the SEC has received thousands of closures. comment letters on it. The Release is available on the Director Nomination and SEC’s website ( Shareholder Communication interp/shtml). Processes Commission and See our February 2004 Financial (Releases 33-8340 and Staff Guidance Reporting letter for further details. 34-48626) In November, the Commission Results of Fortune 500 SAB Codification Update adopted rules designed to make Company Report Reviews In May, the Commission’s staff the operation of boards of directors During 2002 the SEC staff under- issued Staff Accounting Bulletin more transparent to shareholders. took a project to review the annual (SAB) 103, Update of Codification of Staff BDO SEIDMAN, LLP, FINANCIAL REPORTING 11
  12. 12. Accounting Bulletins. SAB 103 gener- in Topic 13 of the Codification of Staff For Further ally did not provide new guidance. Accounting Bulletins to make it con- Rather, it updated the existing SAB sistent with current authoritative Information codification. It revised or rescinded accounting literature. If you would like further informa- portions of the guidance in the pre- The principal revisions con- tion or to discuss the implications vious SAB codification to make it sisted of incorporating certain sec- of these matters, please contact consistent with current accounting tions of the staff’s FAQ document the BDO Seidman, LLP engage- and auditing literature and on revenue recognition into Topic ment partner serving you or one of Commission rules and regulations. 13. SAB 104 also deleted guidance the following partners: The SAB contains a summary of the no longer necessary because of Lee Graul ( changes made. SAB 103 is available recent developments in U.S. GAAP (312) 616-4667 on the SEC’s website ( (primarily the issuance of EITF 00- Jeff Lenz (jlenz@ interps/account/sab103.htm). 21, Revenue Arrangements with Multiple (312) 616-3944 Deliverables, and EITF 99-19, Reporting Wayne Kolins (wkolins@ SAB 104 Revenue Gross as a Principal versus Net (212) 885-8595 The Commission’s staff issued SAB as an Agent). 104, Revenue Recognition, in SAB 104 is available on the December. The SAB updated por- SEC’s website ( tions of the interpretive guidance account/sab104.htm). Material discussed in this Financial Reporting newsletter is meant to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual facts and circumstances. 12 COPYRIGHT 2004, BDO SEIDMAN, LLP