SEC Reporting/Disclosure Issues


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SEC Reporting/Disclosure Issues

  1. 1. SEC HOT TOPICS INSTITUTE SEC Reporting/Disclosure Issues Panel May 15, 2008
  2. 2. SEC Trends Affecting ‘33 & ‘34 Act Filings <ul><li>Recent rulemaking and guidance from the SEC </li></ul><ul><ul><li>Revisions to eligibility requirements for primary Form S-3 offerings </li></ul></ul><ul><ul><li>Revisions to Rules 144 and 145 </li></ul></ul><ul><ul><li>Smaller reporting company regulatory relief </li></ul></ul><ul><ul><li>Revised Form 8-K guidance </li></ul></ul><ul><ul><li>Exclusion of shareholder director nominations from issuer proxy statements </li></ul></ul><ul><ul><li>Exemption of electronic shareholder forums from proxy rules </li></ul></ul>
  3. 3. SEC Trends Affecting ‘33 & ‘34 Act Filings <ul><li>Outlook for further rulemaking per Director John White, Division of Corporation Finance </li></ul><ul><ul><li>Interactive data (XBRL) </li></ul></ul><ul><ul><li>International financial reporting standards (IFRS) and other rulemaking related to international issues </li></ul></ul><ul><ul><li>Updated guidance on use of corporate websites for disclosure of information </li></ul></ul><ul><ul><li>Revisions to the limited offering exemptions in Regulation D </li></ul></ul><ul><ul><li>Recommendations of the Advisory Committee on Improvements to Financial Reporting (CIFiR) regarding materiality and the correction of accounting errors </li></ul></ul>
  4. 4. Assessing Materiality in Current Environment <ul><li>Current materiality standards </li></ul><ul><ul><li>U.S. Supreme Court: TSC Industries v. Northway, Inc. </li></ul></ul><ul><ul><ul><li>“ [T]here must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” </li></ul></ul></ul><ul><ul><li>SEC Staff Accounting Bulletins: </li></ul></ul><ul><ul><ul><li>SAB 99 </li></ul></ul></ul><ul><ul><ul><ul><li>the Staff’s views on using quantitative benchmarks to assess materiality in preparing financial statements </li></ul></ul></ul></ul><ul><ul><ul><li>SAB 108 </li></ul></ul></ul><ul><ul><ul><ul><li>The Staff’s views regarding the process of quantifying financial statement misstatements </li></ul></ul></ul></ul>
  5. 5. Assessing Materiality in Current Environment <ul><li>Recent scrutiny </li></ul><ul><ul><li>Former Acting Chief Accountant Scott Taub: </li></ul></ul><ul><ul><ul><li>“ When the error is large, the presumption is that it is material. Confirming that the SAB 99 qualitative indicators of materiality don’t exist merely confirms that there isn’t additional evidence that the error is material other than its size. … It’s important to recognize that factors that might suggest that a large error is immaterial are likely to be specific to the situation in question.” </li></ul></ul></ul><ul><ul><li>Associate Chief Accountant Todd Hardiman , Division of Corporation Finance: </li></ul></ul><ul><ul><ul><li>“ The analysis that needs to be done on the qualitative side is to identify the factors that indicate that the error is not important to investors despite its significant size. …So ask yourself: Why doesn’t the size of the error matter to the reasonable investor? What is it about your individual facts and circumstances that supports your conclusion? Or in accounting parlance, what qualitative factors exist that make the size of the error unimportant to the reasonable investor? A high hurdle to climb? Perhaps, but with the right facts and circumstances, a surmountable one.” </li></ul></ul></ul>
  6. 6. Assessing Materiality in Current Environment <ul><li>Recent scrutiny </li></ul><ul><ul><li>Commissioner Paul Atkins: </li></ul></ul><ul><ul><ul><li>“ When the SEC takes up this issue, we must approach it by returning to ‘first principles’ – that materiality is determined based upon the objective ‘reasonable investor’ standard. The Commission itself – after proceeding with public notice and comment – should clear up this issue with the full input of the investor, legal, accounting, academic, and business communities.” </li></ul></ul></ul>
  7. 7. Assessing Materiality in Current Environment <ul><li>Selected CIFiR recommendations for additional guidance: </li></ul><ul><ul><li>Evaluation of errors should be on a “sliding scale” (e.g., quantitatively large errors can be immaterial due to qualitative factors) </li></ul></ul><ul><ul><li>How an error is corrected should be based on needs of current investors </li></ul></ul><ul><ul><li>Only restate prior-period financial statements for errors material to those periods </li></ul></ul><ul><ul><li>May not be necessary to amend previous reports to restate financial statements if the next report is being filed soon and will contain all relevant information </li></ul></ul><ul><ul><li>Interim-period restatements do not need to result in annual-period restatements </li></ul></ul><ul><ul><li>Application of materiality of errors identified in prior interim periods and correction of such errors </li></ul></ul>
  8. 8. Assessing Materiality in Current Environment <ul><li>How should we evaluate the materiality of errors? </li></ul><ul><ul><li>Today under SAB 99 and SAB 108? </li></ul></ul><ul><ul><li>Under a “sliding scale”? </li></ul></ul>
  9. 9. Trends in Comment Letters <ul><li>MD&A - Overview: </li></ul><ul><ul><li>“ We note much of your disclosure in this section is very similar to the summary on page [X] and the business section on page [Y]. Please revise to avoid repeating disclosure. The overview in this section should be a balanced, executive-level discussion that identifies the most important themes or other significant matter with which management is concerned primarily in evaluating the company’s financial condition and operating results. Discuss material business opportunities, challenges and risks, such as those presented by known material trends and uncertainties, on which the company’s executives are most focused, and the actions they are taking in response to them. For further guidance on the content and purpose of the ‘Overview,’ see Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations Interpretive Release No. 33-8350 (December 19, 2003) on our website.” </li></ul></ul>
  10. 10. Trends in Comment Letters <ul><li>MD&A – contributing factors: </li></ul><ul><ul><li>“ Throughout this section, you refer to two or more factors that contributed to the reported financial result or material changes over the reported periods. Revise to quantify the amount of the financial result or changes contributed by each of the factors or events that you identify as they relate to revenues, cost of revenues and gross profit, sales and marketing, research and development and general and administrative. Rather than simply using the term “primarily” in describing changes, quantify the amount of the financial result or change that is attributable to the primary source you identify. … See Section III.D of SEC Release 33-6835. In addition to quantifying the dollar effect of the various contributing factors, ensure that you describe the significant developments in the marketplace or at your company that led to the changes.” </li></ul></ul>
  11. 11. Trends in Comment Letters <ul><li>MD&A – research and development projects: </li></ul><ul><ul><li>“ Please disclose the following information for each of your major research and development projects: </li></ul></ul><ul><ul><ul><li>a. The costs incurred during each period presented and to date on the project; </li></ul></ul></ul><ul><ul><ul><li>b. The period in which material net cash inflows from significant projects are expected to commence. </li></ul></ul></ul><ul><ul><li>Regarding a., if you do not maintain any research and development costs by project, disclose that fact and explain why management does not maintain and evaluate research and development costs by project. Provide other quantitative or qualitative disclosure that indicates the amount of the company's resources being used on the project.” </li></ul></ul>
  12. 12. Trends in Comment Letters <ul><li>MD&A – liquidity and capital resources: </li></ul><ul><ul><li>“ On page [X] you disclose that you expect to spend substantial amounts of capital to continue your growth and provide some disclosure about how you will spend the net proceeds of this offering. In all appropriate sections, please revise to further discuss these plans, and indicate the impact that it will have on your liquidity and capital resources. Also, revise to indicate whether the company currently anticipates having to raise additional capital to effectuate its growth strategy.” </li></ul></ul><ul><ul><li>“ Please revise to disclose when you expect you will need additional funding and how much you expect you will need.” </li></ul></ul>
  13. 13. Trends in Comment Letters <ul><li>Segment reporting: </li></ul><ul><ul><li>“ We note your disclosure of revenues by geographic region. It is not clear from this disclosure whether the Company has determined that it operates in more than one segment. Tell us the number of operating segments, the nature of discrete financial information the Chief Operating Decision maker reviews on a periodic basis (operating results by product, services, geographic region etc.) and how you considered paragraphs 10 through 17 of SFAS 131 in determining the number of operating segments.” </li></ul></ul><ul><ul><li>“ You describe several product lines including [W], [X], [Y] and [Z]. Please provide product line disclosure under paragraph 37 to SFAS 131.” </li></ul></ul>
  14. 14. Trends in Comment Letters <ul><li>Stock-based compensation: </li></ul><ul><ul><li>“ Progressively bridge management’s fair market value determinations to the current estimated IPO price range. Reconcile and explain the differences between the mid-point of your estimated offering price range and the fair values included in your analysis. Provide us with a chronology of events leading to the filing of your IPO, including when discussions began with potential underwriters. We are deferring final evaluation of stock-based compensation until your estimated offering price is specified and may have further comment in this regard.” </li></ul></ul>
  15. 15. Trends in Comment Letters <ul><li>Stock-based compensation: </li></ul><ul><ul><li>“ We note that on page [X] you refer to using the valuation of an independent third party when determining fair value of your common stock. While management may elect to take full responsibility for valuing the equity instruments, if you choose to continue to refer to the expert in any capacity, please revise the filing to name the independent valuation expert and include its consent as an exhibit.” </li></ul></ul><ul><ul><li>“ [Y]ou state that “our board directors from time to time has also relied upon valuations.” We believe that this disclosure constitutes reference to reliance upon an independent valuation consultant. Please either name this independent valuation consultant here and in your Experts section and provide their consent in the registration statement or remove this reference.” </li></ul></ul>
  16. 16. References and Resources <ul><li>Materials referenced in presentation </li></ul><ul><li>Director White’s speech at the Securities Regulation Institute in January 2008 can be found at </li></ul><ul><li>TSC Industries v. Northway, Inc., 426 U.S. 438, 449 (1976) </li></ul><ul><li>SAB 99 can be found at </li></ul><ul><li>SAB 108 can be found at </li></ul><ul><li>Former Acting Chief Accountant Taub in an article entitled “Avoiding Unnecessary Restatements” in Compliance Week (May 8, 2007) </li></ul><ul><li>Associate Chief Accountant Hardiman’s remarks before the 2007 AICPA National Conference on Current SEC and PCAOB Developments in December 2007 can be found at </li></ul><ul><li>Commissioner Atkins’ remarks to the SEC Speaks in 2008 Program of the Practicing Law Institute in February 2008 can be found at </li></ul><ul><li>The CIFiR Progress Report (February 2008) can be found at </li></ul><ul><li>Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations Interpretive Release No. 33-8350 (December 19, 2003) can be found at </li></ul><ul><li>SEC Interpretation: Management's Discussion and Analysis of Financial Condition and Results of Operations; Certain Investment Company Disclosures Release No. 33-6835 (May 18, 1989) can be found at </li></ul>
  17. 17. References and Resources <ul><li>Division of Corporation Finance “Current Issues and Rulemaking Projects Quarterly Update,” Section VIII—Industry Specific Issues—Accounting and Disclosure by Companies Engaged in Research and Development Activities (March 31, 2001) can be found at </li></ul><ul><li>SFAS 131, “Disclosures about Segments of an Enterprise and Related Information,” can be found at </li></ul><ul><li>Additional resource materials included in binder </li></ul><ul><li>Ernst & Young Hot Topic: “Allowing Smaller Public Companies to use Form S-3 and Shelf Registration” </li></ul><ul><li>Cooley Alert! “SEC Approves Major Changes to Rule 144 and Rule 145” </li></ul><ul><li>Ernst & Young Hot Topic: “Smaller Reporting Company Relief & Simplification” </li></ul><ul><li>Exchange Act Form 8-K interpretations updated April 10, 2008 </li></ul><ul><li>Ernst & Young Hot Topic: “Summary of SEC Proposal – Revised Regulation D Offering Exemptions” </li></ul><ul><li>Ernst & Young Hot Topic: “Compendium of Significant Accounting and Reporting Issues discussed at 2007 AICPA National Conference on Current SEC and PCAOB Developments” </li></ul><ul><li>The Changing Nature and Consequences of Public Company Financial Restatements 1997-2006, a study for the Department of the Treasury </li></ul><ul><li>Ernst & Young: “SEC Comments and Trends” </li></ul><ul><li>Ernst & Young: “SEC Comments and Trends for Technology Companies” </li></ul>