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Chapter 14 SEC Reporting Note: We provide a summary of the slides and suggestions on how they might be used in the instructor’s manual for each chapter. We have attempted to provide PowerPoint slides that will be useful to a broad set of users. Since instructors often have different styles and preferences, we have attempted to include slides that will accommodate different approaches and that can be adapted to classes with different levels of preparation. For example, some instructors prefer to introduce the material before students have read the chapter. We have tried to facilitate these types of introductory discussions by including slides that replicate key points from the chapter. Other instructors expect students to have read the chapter and attempted homework problems before coming to class. As a result, they may not find it useful to review all of the topics in the chapter or to include slides that simply review many of the details they expect students to study before class. However, instructors following this approach often like to use sample exercises and problems built into the slides that allow them to have extended discussions or to facilitate group interaction in class. If instructors elect to spend two class periods on the same subject, they might find a combination of both styles to be useful by first introducing foundational material before students have read the chapter and studied the topic, followed by an extended discussion the next class period after students have read the chapter and attempted homework problems. We have tried to develop slides that can facilitate a flexible approach to allow instructors to select the slides that best match their objectives and style for class discussions. This is the reason we are including a large number of slides for some chapters in the text. We do not expect all instructors to use all slides, but the slide files should help support different teaching approaches and allow instructors to select the subset of slides that best matches their specific discussion objectives. The slides are organized by learning objective. We have included a slide at the beginning of each learning objective to show where the new material begins. Instructors may or may not want to use these learning objective slides in class. We provide them primarily as a way of organizing the material. We also include short multiple choice questions at the end of most learning objectives. Some instructors find it useful to pause periodically during class to assess students’ level of understanding. For this reason, we include several “practice quiz questions” that can be used throughout class discussions to engage students, help them focus on key points, or to facilitate group interaction. Finally, we provide longer exercises and problems that many instructors find useful in assessing understanding and encouraging group learning.
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Understand the SEC’s structure and regulatory authority.
Learning Objective 14-1 Understand the SEC’s structure and regulatory authority.
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Securities and Exchange Commission (SEC) Reporting
The Securities and Exchange Commission (SEC) is an independent federal agency created in 1934, responsible for regulating securities markets. The ability of companies to raise capital in the stock markets and the high trading volumes are indications of the SEC’s success in maintaining an effective marketplace for companies issuing securities and for investors seeking capital investments. 3
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Securities and Exchange Commission (SEC) Reporting
The Genesis of Securities Regulation 13th century: King Edward establishes a Court of Aldermen to regulate security trades in London. 18th century: England’s Parliament passed several acts (the Bubble Acts), to control questionable security schemes. 1790: Creation of the New York Stock Exchange was created to serve as a clearinghouse for securities trades between its members. 4
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Securities and Exchange Commission (SEC) Reporting
The Genesis of Securities Regulation 1911: States began passing what were called “blue sky laws” to regulate the offering of securities by companies which did not have a sound financial base. 1920s: Era of heavy stock speculation by many individuals. October 1929: Beginning of the Great Depression. The Federal Securities Acts of 1933 and 1934 were passed as part of President Franklin D. Roosevelt’s New Deal legislation. 5
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Securities and Exchange Commission (SEC) Reporting
The Securities Act of 1933 Regulated the initial distribution of security issues by requiring companies to make “full and fair” disclosure of their financial affairs before their securities could be offered to the public. The Securities Exchange Act of 1934 Required all companies whose stocks were traded on a stock exchange to periodically update their financial information. Created the Securities and Exchange Commission and assigned it the responsibility of administering both the 1933 and 1934 acts. 6
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Securities and Exchange Commission (SEC) Reporting
The SEC has the legal responsibility to regulate trades of securities and to determine the types of financial disclosures that a publicly held company must make. The SEC’s role is to ensure full and fair disclosure; it does not guarantee the investment merits of any security. 7
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International Harmonization of Accounting Standards for Public Offerings
The International Accounting Standards Board (IASB) is working with the Financial Accounting Standards Board (FASB) to converge on a uniform set of accounting and financial reporting standards that can be used by all companies seeking financing through any of the world’s major stock markets, including those of the United States. 8
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International Harmonization of Accounting Standards for Public Offerings
In 2007, the SEC published the following: Securities Act Release No Under this, financial statements from foreign private issuers will be accepted by the SEC without reconciliation to U.S. GAAP, if they are prepared using IFRSs as issued by the IASB. Securities Act Release No A Concept Release. If U.S. issuers are allowed to use IFRSs in their filings with the SEC, multinational U.S. companies operating in several countries could use just one set of accounting and financial reporting standards for all of their global operations. 9
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Securities and Exchange Commission (SEC)
Organizational structure Division of Corporation Finance: develops and administers the disclosure requirements for the securities acts and reviews all registration statements and other issue-oriented disclosures. Division of Enforcement: directs the SEC’s enforcement actions. Division of Investment Management: regulates investment advisers and investment companies. Division of Economic and Risk Analysis: integrates financial economics and rigorous data analytics into the core mission of the SEC. Division of Trading and Markets: regulates national securities exchanges, brokers, and dealers of securities. 10
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Organizational Structure of the SEC
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Securities and Exchange Commission
Laws administered by the SEC: Trust Indenture Act of 1939 Investment Company Act of 1940 Investment Advisors Act of 1940 Securities Investor Protection Act of 1970 Sarbanes-Oxley Act of 2002 Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 Jumpstart Our Business Startups (JOBS) Act of 2012 The SEC is often asked for assistance in the administration of two other major laws: Foreign Corrupt Practices Act of 1977 Federal Bankruptcy Acts 12
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Securities and Exchange Commission
Two major regulations Regulation S-X and Regulation S-K govern the preparation of financial statements and associated disclosures made in reports to the SEC. Regulation S-X presents the rules for preparing financial statements, footnotes, and the auditor’s report. Regulation S-K covers all nonfinancial items, such as management’s discussion and analysis of the company’s operations and financial position. 13
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Securities and Exchange Commission
The regulatory structure The Accounting and Auditing Enforcement Releases (AAERs) present the results of enforcement actions taken against accountants, brokers, and other participants in the filing process. The Staff Accounting Bulletins (SABs) allow the Commission’s staff to make announcements on technical issues with which it is concerned as a result of reviews of SEC filings. 14
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The Regulatory Structure
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The Regulatory Structure
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Practice Quiz Question #1
Which of the following statements is true about the SEC? a. The SEC was created in response to the Korean War in the mid-1950s. b. The SEC has the legal responsibility to regulate trades of securities c. The SEC’s role is to ensure full and fair disclosure and it guarantees investments. d. The SEC is managed directly by the U.S. Vice President. e. Staff Accounting Bulletins (SABs) allow the SEC staff to make announcements regarding government social events.
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Understand the process of registering securities with the SEC.
Learning Objective 14-2 Understand the process of registering securities with the SEC.
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Issuing Securities: The Registration Process
Companies wishing to sell debt or stock securities in interstate offerings to the general public are generally required by the Securities Act of 1933 to register those securities with the SEC. The basic financial statements required to be provided are: Two years of balance sheets Three years of statements of income Three years of statements of cash flows Three years of statements of shareholders’ equity Prior years’ statements are presented on a comparative basis with those for the current period. The SEC requires at least five years of selected financial information presenting key numbers. 19
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Issuing Securities: The Registration Process
A number of types of securities and securities transactions are exempt from registration: Commercial paper (notes) with a maturity of nine months or less. Issues in which the securities are offered and sold only within one state. Securities exchanged by an issuer exclusively with its existing shareholders with no commission charged . Issuances of securities by governments, banks, savings and loan associations, farmers, co-ops, and common carriers regulated by the Interstate Commerce Commission. Securities of nonprofit religious, educational, or charitable organizations. 20
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Issuing Securities: The Registration Process
Under the SEC’s Regulation A for issuances up to $5,000,000 within a 12-month period can be exempt from registration if the entity files a notice with the SEC and an “offering circular” containing financial and other information provided to the persons to whom the offer is made. Some required disclosures of financial statements and other financial information fall under Regulation A. 21
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Issuing Securities: The Registration Process
Regulation D presents three exemptions from full registration requirements for private placements: Rule 504 exempts small issuances up to $1,000,000 within a 12-month period to any number of investors. Rule 505 exempts issuances up to $5,000,000 within a 12-month period. The sales can be made to up to 35 “unaccredited investors” and to an unlimited number of “accredited investors.” Rule 506 allows private placements of an unlimited amount of securities and applies, in general, the same rules as Rule 505 except the maximum of 35 unaccredited investors must be sophisticated investors. 22
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Issuing Securities: The Registration Process
The offering process begins with the selection of an investment banker (an “underwriter”). An underwriter provides marketing information and directs the distribution of the securities. The underwriting agreement is a contract between the company and the underwriter and specifies such items as the underwriter’s responsibilities and the final disposition of any unsold securities remaining at the end of the public offering. 23
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Issuing Securities: The Registration Process
The Registration Statement The process of public offerings of securities begins with the preparation of the registration statement. The company must select one from among approximately 20 different forms the SEC currently has for registering securities. The most common: Form S-1: the most comprehensive registration statement. Form S-2: an abbreviated form for present registrants who have other publicly traded stock. Form S-3: a brief form available for large, established registrants whose stock has been trading for several years. 24
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Issuing Securities: The Registration Process
The Registration Statement Form S-1 has two different levels of disclosure: Part I: the “prospectus” is intended primarily for investors. Part II: includes more detailed information. The registration statement must be signed by the principal executive, financial, and accounting officers, as well as a majority of the company’s board of directors. The company then submits its registration statement to an SEC review by the Division of Corporation Finance. 25
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Issuing Securities: The Registration Process
SEC review and public offering Most first-time registrants receive a “customary review,” which is a thorough examination by the SEC that may result in: Acceptance, or A comment letter specifying the deficiencies that must be corrected. Established companies that already have stock widely traded generally are subject to a summary review or a cursory review. 26
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Issuing Securities: The Registration Process
SEC review and public offering Once the registration statement becomes effective, the company may begin selling securities to the public. This review period is 20 days unless the company receives a comment letter from the SEC. Between the time the registration statement is presented to the SEC and its effective date, the company may issue a preliminary prospectus, referred to as a red herring prospectus, which provides tentative information to investors about an upcoming issue. 27
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Issuing Securities: The Registration Process
SEC review and public offering The company prepares a “tombstone ad” in the business press to inform investors of the upcoming offering. The time period between the initial decision to offer securities and the actual sale may not exceed 120 days. 28
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Issuing Securities: The Registration Process
SEC review and public offering The SEC devised the shelf registration rule for large, established companies with other issues of stock already actively traded. These companies may file a registration statement with the SEC for a stock issue that may be “brought off the shelf ” and, with the aid of an underwriter, updated within a very short time, usually two to three days. 29
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Issuing Securities: The Registration Process
Accountants’ legal liability in the registration process Under section 11 of the 1933 Act, accountants are liable for any materially false or misleading information to the effective date of the registration statement. The underwriters handling the sale of the securities often require a comfort letter from the registrant’s public accountants for the period between the filing date and the effective date. This letter provides additional evidence that the public accountant has not found any adverse financial changes since the filing date. 30
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Practice Quiz Question #2
Which of the following is not a step in the registration process? a. The company selects and underwriter. b. The company prepares a registration statement. c. The SEC reviews the registration statement. d. The SEC’s Chief Accountant signs a letter of attestation regarding the offering. e. The company begins selling securities.
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Understand periodic reporting requirements.
Learning Objective 14-3 Understand periodic reporting requirements.
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Periodic Reporting Requirements
Companies with more than $10 million in assets and whose securities are held by more than 500 persons must file annual and other periodic reports as updates on their economic activities. The three basic forms used for this updating are Form 10-K Form 10-Q Form 8-K 33
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Periodic Reporting Requirements
Form 10-K is the annual filing to the SEC Accelerated filers are companies having at least $75 million in aggregate market value that have been subject to the periodic and annual reporting requirements for at least one year. Must file their Form 10-K within 60 days after the end of the company’s fiscal year. Small businesses, and others who do not meet the requirements for an accelerated filer, have until 90 days after the end of their fiscal years. 34
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Periodic Reporting Requirements
Form 10-K has four parts Parts I, II, and III include: The management’s discussion and analysis. The audited financial statements and footnotes. The report by management on the internal control structure and the assessment of the effectiveness of those controls. The auditor’s opinion. At least five years of condensed financial information disclosures. Part IV contains additional schedules and exhibits. 35
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Periodic Reporting Requirements
Form 10-Q is the quarterly report to the SEC Accelerated filers must file a Form 10-Q within 35 days after the end of each of their first three quarters. Other companies must file within 45 days after the end of each of their first three quarters. No Form 10-Q is filed for the fourth quarter because that is when the Form 10-K is filed. Form 10-Q has two parts Part I includes comparative financial statements prepared in accordance with ASC 270 and ASC 740. Part II is an update on significant matters occurring since the last quarter. 36
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Periodic Reporting Requirements
Form 8-K is used to disclose unscheduled material events Companies must file a Form 8-K within four business days of the occurrence of a “triggering event.” 37
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Periodic Reporting Requirements
Schedule 13D Filed by those who acquire a beneficial ownership of more than 5 percent of a class of registered equity securities and must be filed within 10 days after such an acquisition. Beneficial ownership: directly or indirectly having the power to vote the shares or investment power to sell the security. Proxy statements Materials submitted to shareholders for votes on corporate matters. In many cases, voting on these matters takes place at the annual meeting but it may also occur at a special meeting. 38
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Periodic Reporting Requirements
Accountants’ legal liability in periodic reporting The 1934 Securities Exchange Act provides for a limited level of legal exposure from involvement in the preparation and filing of periodic reports. Civil liability is imposed for filing materially false or misleading statements. Accountants have due diligence defenses to combat any lawsuits brought under the 1934 Act. 39
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EDGAR System Electronic Data Gathering, Analysis, and Retrieval (EDGAR) System An electronic filing system developed by the SEC. Under this system, firms electronically file directly by using computers, facilitating the data transfer and making public data more quickly available. Increases the efficiency and fairness of the securities market by expediting the receipt, acceptance, dissemination, and analysis of time-sensitive data filed with it. 40
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Practice Quiz Question #3
Which of the following is not one of the three required disclosures of publicly traded companies? a. Form 10-K b. Form 10-Q c. Form 8-K d. Form 8-Q
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Understand requirements for management reporting laws.
Learning Objective 14-4 Understand requirements for management reporting laws.
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Foreign Corrupt Practices Act of 1977
Congress passed the Foreign Corrupt Practices Act of 1977 (FCPA) as a major amendment to the Securities Exchange Act of 1934. The FCPA has two major sections: Part I prohibits foreign bribing of foreign governmental or political officials for the purpose of securing a contract or otherwise increasing the company’s business. Part II requires all public companies to maintain accurate records and an adequate system of internal control. 43
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Sarbanes-Oxley Act of 2002 Signed into law on July 30, 2002
Gained impetus after the revelations about accounting and financial mismanagement at Enron, WorldCom, and others. The legislation (broadly known as SOX) has a number of major implications for accountants. Its supporters hoped the act would minimize corporate governance accounting and financial reporting abuses and help restore investor confidence in the financial reports of publicly traded companies. 44
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Sarbanes-Oxley Act – Major Sections
Title I: Public Company Accounting Oversight Board Title II: Auditor Independence Title III: Corporate Responsibility Title IV: Enhanced Financial Disclosures Title V: Analyst Conflicts of Interest Title VI: Commission Resources and Authority Title VII: Studies and Reports Title VIII: Corporate and Criminal Fraud Accountability Title IX: White-Collar Crime Penalty Enhancements Title X: Sense of Congress Regarding Corporate Tax Returns Title XI: Corporate Fraud and Accountability 45
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Sarbanes-Oxley Act – Major Sections
Title I: Public Company Accounting Oversight Board (PCAOB) Established a new accounting oversight board to regulate accounting firms and be responsible for establishing or modifying auditing and attestation standards. The SEC administers the PCAOB and is responsible for appointing its five full-time members. The board manages regular inspections of the registered accounting firms’ operations and auditing processes. Broadly referred to by the nickname “Peekaboo.” 46
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Sarbanes-Oxley Act – Major Sections
Title II: Auditor Independence Auditors are prohibited from offering certain nonaudit services to their audit clients. These services include information systems design and implementations, appraisals or valuation services, internal audits, human resources services, legal or expert services not related to audit services, and bookkeeping services. Accounting firms must determine whether to provide audit or nonaudit services to a company; they cannot provide both to the same company. Both the lead audit partner and the audit review partner for publicly held companies must be rotated every five years. A CEO, controller, CFO, chief accounting officer, or equivalents, cannot be employed by the company’s audit firm during the 1-year preceding an audit. 47
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Sarbanes-Oxley Act – Major Sections
Title III: Corporate Responsibility Audit committees must be composed of nonmanagement members of a company’s board of directors. Auditors must report directly to, and have their work overseen by the company’s audit committee, not the company’s management. Both CEO and CFO of publicly traded companies must provide a signed statement to accompany each annual and quarterly financial report. They certify that the financial statements and disclosures fairly present, in all material respects, the issuer’s operations and conditions. 48
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Sarbanes-Oxley Act – Major Sections
Title IV: Enhanced Financial Disclosures Financial reports filed with the SEC must reflect all material correcting adjustments and all material off-balance sheet transactions and relationships that have a material effect on the issuer’s financial status. Each annual filing of a stock issuer must contain an internal control report by management that reports on the existence and effectiveness of the company’s internal control over financial reporting. Management’s internal control report must include the following items: A statement that management is responsible for establishing and maintaining an adequate system. The identification of the framework used to evaluate the internal controls. A statement as to whether the internal control is effective as of year-end. The disclosure of any material weaknesses in the internal control system. 49
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Sarbanes-Oxley Act – Major Sections
Title V: Analyst Conflicts of Interest Research analysts, brokers, and dealers must report the following for any company for which they prepare a research report: Any securities held in the company. Any compensation received from the company. If the company was a client of the broker/dealer. 50
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Sarbanes-Oxley Act – Major Sections
Title VI: Commission Resources and Authority Increases funding for the SEC and its disciplinary and litigation authority over auditors, attorneys, brokers and dealers, and others who practice in the securities markets and who have engaged in illegal, unethical, or improper professional conduct. 51
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Sarbanes-Oxley Act – Major Sections
Title VII: Studies and Reports The Government Accountability Office (GAO) and SEC are charged with conducting various studies concerning topics such as: factors leading to consolidation of public accounting firms and the impacts of that consolidation, the role of credit rating agencies in the securities markets, and whether investment banks and financial advisers assisted public companies in earnings manipulation and obfuscation of financial conditions. 52
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Sarbanes-Oxley Act – Major Sections
Title VIII: Corporate and Criminal Fraud Accountability Establishes severe penalties for anyone who destroys records, commits securities fraud, or fails to report fraud. “Whistle-blower protection” is provided to employees of companies or the accounting firm who lawfully assist in an investigation of fraud or other criminal conduct by federal regulators, Congress, or supervisors. 53
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Sarbanes-Oxley Act – Major Sections
Title IX: White-Collar Crime Penalty Enhancements Increases minimum penalty for mail and wire fraud from 5 to 10 years. Makes it a crime to tamper with a record or impede official proceedings. Allows the SEC to prohibit anyone convicted of securities fraud from being an officer or director of any publicly traded company. Criminal liability up to five years for corporate officers who fail to certify financial reports or who wilfully certify financial statements knowing they do not comply with the act. 54
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Sarbanes-Oxley Act – Major Sections
Title X: Sense of Congress Regarding Corporate Tax Returns Congress’s expression that CEOs should sign a corporation’s federal income tax return. 55
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Sarbanes-Oxley Act – Major Sections
Title XI: Corporate Fraud and Accountability Increased the penalties for persons using deceptive devices, engaging in fraudulent transactions, or otherwise acting to impede an official proceeding. Increased the penalties for violations of the Securities Exchange Act of 1934 up to $25 million and up to 20 years in prison. 56
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Dodd-Frank Wall Street Reform and Consumer Protection Act
Introduced by Senator Chris Dodd and revised by Congressman Barney Frank, the law became effective July 21, 2010. Establishes new government agencies: The Financial Stability Oversight Council and Orderly Liquidation Authority: oversees the financial stability of firms that have a significant influence on the economy (companies described as “too big to fail.” The Consumer Financial Protection Bureau (CFPB): responsible for preventing predatory mortgage lending and ensuring that consumers understand the mortgage terms prior to finalizing paperwork. The SEC Office of Credit Ratings: ensures agencies provide meaningful and reliable credit ratings. 57
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Jumpstart Our Business Startups (JOBS) Act
Signed into law on April 5, 2012. Increases job creation and economic growth by improving access to the pubic capital markets for emerging growth companies. Contains provisions designed to ease the raising of capital for private companies. Stipulates financial statement requirements based on amounts raised annually as well as specific provisions about how those funds can be raised. Defines an “emerging growth company” and stipulates financial statement requirements as well as exemptions from certain accounting requirements. 58
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Practice Quiz Question #4
Which of the following statements is NOT true about management reporting laws? a. The Foreign Corrupt Practices Act of (FCPA) is a major amendment to the Securities Exchange Act of 1934. b. The FCPA prohibits foreign bribes and requires internal controls. c. The Sarbanes-Oxley Act of 2002 (SOX) was enacted due to suspected fraud of Microsoft Inc. executives. d. SOX requires regular, detailed internal control testing.
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Understand disclosure requirements.
Learning Objective 14-5 Understand disclosure requirements.
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Disclosure Requirements
Management Discussion and Analysis MD&A of a company’s financial condition and results of operations is part of the basic information package required in all major filings with the SEC. Items now required in the MD&A: Liquidity Capital resources Results of operations Off-balance sheet arrangements Tabular disclosure of contractual obligations 61
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Disclosure Requirements
Pro forma disclosures Essentially “what-if ” financial presentations often taking the form of summarized financial statements. Show the effects of major transactions that occur after the end of the fiscal period or that have occurred during the year but are not fully reflected in the company’s historical cost financial statements. 62
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Practice Quiz Question #5
Which of the following is true about additional financial disclosures? a. MD&A stands for “Management Disclosure and Admissions.” b. MD&A is required in all major SEC filings. c. Pro forma disclosures are “what-if ” financial presentations often taking the form of summarized financial statements . d. Pro forma disclosures show the effects of major transactions that have occurred during the year but are not reflected in the financial statements.
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Conclusion The End
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