1. Financial Reporting and the Securities and Exchange Commission
Chapter Twelve
Financial Reporting and the Securities and Exchange Commission
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Securities and Exchange Commission (SEC)
12-2
Established by the Securities Exchange Act of 1934.
Independent
Agency of the
Federal
Government
SEC
Mandate is to ensure that complete and reliable information is available to investors
Direct authority
Applies to Publicly
Held
Companies
Major Influence on the Development of US GAAP

3. Securities and Exchange Commission (SEC)
12-3
Headed by 5 commissioners appointed by the President (with Senate consent)
Commissioners serve 5-year, staggered terms
SEC
The chairperson is usually from the same political party as the President
Only 3 of 5 can belong to the same political party
Deposited over $1.076 Billion of fees in 2003

4. Office of Information Technology Office of the Chief Accountant
12-4
Office of Information Technology
Office of the Chief Accountant
Division of Investment Management
Division of Enforcement
SEC
Office of Compliance Inspections and Examinations
Division of Market Regulation
Division of Corporate Finance

5. Federal Securities Laws
12-5
Spurred by the Great Depression
following the 1929 Stock MarketCrash,
Congress enacted
Securities Exchange Act of 1934
Securities Act of 1933
Regulates the initial offering of securities by a company or underwriter.
Regulates the subsequent trading of securities through brokers and exchanges.
The 1934 Act Established the SEC

6. Mission of the SEC Protect investors
12-6
Protect investors
Maintain fair, orderly and efficient markets
Facilitate capital formation
(Source:

7. Goals of the SEC
12-7
Prohibiting dissemination of materially misstated information.
Ensuring full & fair disclosure to all investors.
Preventing misuse of information by inside parties.
Regulating the operation of securities markets.

8. Full and Fair Disclosure
12-8
Securities Exchange Act of 1934
Securities Act of 1933
Public Utility Holding Company Act of 1935
New securities must be registered prior to public sale.
Requires continuous reporting by publicly traded companies.
Prohibits fraudulent and unfair behavior.
Requires registration of interstate holding companies of public utilities.

9. Full and Fair Disclosure
12-9
Trust Indenture Act of 1939
Investment Advisers Act of 1940 and Securities Investor Protection Act of 1970
Requires registration of indentures related to public issue of bonds, notes, etc.
Requires registration of investment advisors and requires them to follow certain standards.
Investment Company Act of 1940
Requires registration of investment companies.

10. Full and Fair Disclosure
12-10
Foreign Corrupt Practices Act of 1977
Insider Trader Sanctions Act of 1984 & Insider Trader and Securities Fraud Enforcement Act of 1988
Amends Securities Exchange Act of Requires maintenance of accounting records and adequate internal accounting controls.
Increase penalties against persons who profit from illegal use of inside information.

11. Shaken Confidence
12-11
During 2001 and 2002, numerous corporate scandals shook the confidence of investors in the reliability of financial statement information
Causes included:
Greed on the part of corporate executives
Failure of corporate governance
Audit failures
Unreasonable market expectations
Overburdened SEC

12. Full and Fair Disclosure
12-12
Sarbanes-Oxley Act of 2002 E
Designed as a response and answer to the numerous corporate accounting scandals that came to light in 2001 and 2002.

13. The SEC’s Impact on Financial Reporting
12-13
In addition to audited financial statements, Rule 14c-3 of the 1934 Act requires the following to be included in proxy statements received by shareholders:
5-year summary of operations.
Description of the business’ activities.
3-year summary of industry segments.
Listing of company directors and executive officers.
Market price of the common stock for each quarter of the last 2 years.
Restrictions on the company’s ability to pay dividends.
MD&A

14. The SEC’s Impact on Financial Reporting
12-14
All nonaudit services provided by the independent auditing firm.
Whether the Board of Directors approved all nonaudit services and considered whether they would impair the auditor’s independence.
The % of nonaudit fees to the total annual audit fee.
Individual nonaudit fees > 3% of the annual audit fee.
Certain information about the auditor must also be disclosed.

15. Corporate Scandals Led to Sarbanes-Oxley in July 2002
12-15
WorldCom:
Improperly Added
$9 Billion of
Income
Enron:
Ken Lay received $152.7
Million in the year
His firm collapsed,
Zeroing out pensions
Adelphia Communications’ founder
“looted” the company of
Over $2 Billion

16. Sarbanes-Oxley Act of 2002 Section 101
12-16
Creation of Public Company Accounting Oversight Board
Under the oversight and enforcement authority of the SEC
Board charged with:
Establishing auditing, quality control, and independence standards.
Performing periodic inspections of registered public accounting firms.
Could potentially replace the Auditing Standards Board of the AICPA.

17. Sarbanes-Oxley Act of 2002 Section 101
12-17
Creation of Public Company Accounting Oversight Board
Five members
Allows only 2 of the 5 to be CPAs, past or present.
Remaining 3 must NOT be accountants.
The Board is funded through mandatory fees levied on all publicly traded companies.
Accounting firms must register with the Board and pay fees.
Applies to foreign firms as well.

18. Sarbanes-Oxley Act of 2002 Auditor Independence
12-18
To ensure future independence of audit firms, some previously common concurrent services are now prohibited.
Bookkeeping services.
AIS design and implementation.
Appraisal or valuation services.
Internal audit outsourcing.
Management functions/Human Resource Management.
Investment advising.
Legal services or expert services.

19. Sarbanes-Oxley Act of 2002 Audit Committees
12-19
Audit Committees will also be expected to exercise more oversight in the future.
Financial Experts on the BOD must be identified in the annual report.
Experience with accounting matters like the ones used in the company.
Must have served as an auditor, CFO, controller, or Chief Accounting Officer of a public company.
Independence of “financial experts” must be disclosed.
The Committee hires the external auditor.
The auditor now reports to the Committee instead of to management.

20. Other Sarbanes-Oxley Act Requirements
12-20
CEOs and other top corporate executives must vouch for the accuracy of financial statements
Registration required for public accounting firms which prepare, issue or participate in the presentation of an audit report for an “issuer.” This includes some foreign auditing firms.
Boards must have audit committees drawn from independent directors
Registered companies can no longer make loans to corporate directors

21. Information Required of Applicants Seeking PCAOB Registration
12-21
A list of all accountants participating in the audit report of any client qualifying as an issuer
Annual fees received from each issuer (showing division between audit and nonaudit services)
Information about any pending criminal, civil or administrative actions against the firm or any person associated with it
Information regarding disagreements between the auditing firm and the issuer during the previous year

22. SEC Requirements
12-22

23. The SEC’s Authority Over GAAP
12-23
The SEC allows the FASB to set GAAP.
Congress has assigned GAAP-setting authority to the SEC.
The FASB’s standards can always be overridden by the SEC.
Authority only extends to publicly traded companies.

24. The SEC’s Authority Over GAAP
12-24
The SEC does issue authoritative documents.
Financial Reporting Releases (FRR’s)
Staff Accounting Bulletins (SAB’s)
Supplements to Regulations S-K and S-X
Views on current accounting and disclosure matters.

25. Additional SEC Authority
12-25
When deemed necessary, the SEC may:
Require additional disclosure
Establish a moratorium on specific accounting practices
Challenge individual statements (forcing a specific registrant to change its filings)
Overrule the FASB

26. Registration Statements
Filings with the SEC
12-26
Two basic categories of filings
Registration Statements
Periodic Filings

27. SEC Fees
12-27
The SEC charges a registration fee based on the values of securities offered. While small (in 1999 it was of 1 percent) this had created a surplus of $5 billion by the end of fiscal 2006
This has been the source of debate:
Is this a revenue source for the government?
Are corporations being overcharged for registration?
Is the SEC sufficiently funded?

28. Common SEC Registration Statement Forms
12-28

29. Registration Process
12-29
Registration Statements delivered to SEC
Review by Div. Of Corp. Finance
Deficiency letter sent to registrant
Note: This process is both time-consuming and expen$ive.
Once the registration is effective, the securities can be sold.
Approved after deficiencies are cleared

30. Registration Requirements
12-30
PART I
Audited financial Statements.
An explanation of the use of the proceeds.
A description of the security risks.
A description of the business.
General contents of SEC registration reports.
PART II
Used by the SEC staff.
Includes additional information about the company.

31. Offerings Exempt from SEC Filing
12-31
Securities issued by governments, banks, and S&L’s
Securities issued that are restricted to a company’s own existing shareholders.
Offerings < $5 million
Securities issued by non-profit organizations
Offerings < $1 million to be made within a 12-month period.
Offerings < $5 million made to 35 or fewer investors within a 12-month period.
Private placement of securities to < 36 investors who already have knowledge of the company.

32. Periodic Filings with the SEC
12-32
Form 10-K
Form 10-Q
Annual report filed within 90 days of fiscal year-end.
Includes audited financial statements.
Quarterly report filed within 45 days of end of quarter.
Financial statement are unaudited.
Form 8-K
Used to disclose a unique or significant happening.

33. Proxy Statements
12-33
A document that allows the board of directors to vote on behalf of a stockholder.
Must be filed with SEC 10 days prior to distribution.
Needs to indicate on whose behalf the solicitation is made.
Must disclose fully all matters that are to be voted on at the meeting
Has to be accompanied by an annual report (usually)

34. EDGAR
12-34
EDGAR is the acronym for the SEC’s “Electronic Data Gathering and Retrieval” System
Designed to reduce the overwhelming paper flow into the SEC
Allows for public access to SEC filings and information through the Internet

35. Summary
12-35
The SEC, created in the depths of the Great Depression, has been entrusted with the oversight of public capital markets in the United States
The SEC has enormous influence over accounting practices and has the legal authority to establish GAAP
Recent corporate scandals led to the Sarbanes-Oxley Act of 2002, which has radically altered the accounting oversight function in the United States

36. Possible Criticisms
12-36
The PCAOB, which now oversees auditing in the United States, has a majority of non-accountants. This has overturned the American accounting tradition of professional self-regulation, which has attracted much critical attention.
The SEC has deflected much of the criticism for the corporate scandals of the early 2000’s onto the auditing profession. Some critics feel that it is the SEC which needs an overhaul.
WHAT DO YOU THINK????