14-2 Learning Objective 1 Understand the SEC’s structure and regulatory authority.
14-3 SEC 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
14-4 History of Securities Regulation Thirteenth century – King Edward establishes a Court of Aldermen to regulate security trades in London Eighteenth century – England’s Parliament passed several acts (the Bubble Acts), to control questionable security schemes 1790 – Creation of the New York Stock Exchange
14-5 History 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 The Great Depression The Federal Securities Acts of 1933 and 1934
14-6 History of Securities Regulation 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
14-7 History of Securities Regulation 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
14-8 EDGAR System EDGAR (Electronic Data Gathering, Analysis, and Retrieval) 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
14-9 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
14-10 International Harmonization of Accounting Standards for Public Offerings In 2007, the SEC published Securities Act Release No. 33-8879 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. 33-8831 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
14-11 Securities and Exchange Commission 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 Market Regulation – Regulates national securities exchanges, brokers, and dealers of securities
14-12 Securities and Exchange Commission Organizational Structure of the SEC
14-13 Securities and Exchange Commission Laws administered by the SEC Public Utility Holding Company Act of 1935 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 The SEC is often asked for assistance in the administration of two other major laws: Foreign Corrupt Practices Act of 1977 Federal Bankruptcy Acts
14-14 Securities and Exchange Commission The regulatory structure 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
14-15 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 SEC staff to make announcements on technical issues with which it is concerned as a result of reviews of SEC filings
14-18 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. 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.
14-19 Learning Objective 2 Understand the process of registering securities within the SEC.
14-20 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 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
14-21 Issuing Securities: The Registration Process A number of types of securities and securities transactions are exempt from registration: Commercial paper with a maturity of nine months or less Intrastate 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 The antifraud provisions of the securities acts still apply
14-22 Issuing Securities: The Registration Process Small issues under the SEC’s Regulation A for issuances up to $5,000,000 within a 12-month period can be exempt if there is a notice filed 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
14-23 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 of Rule 505 except the maximum of 35 unaccredited investors must be sophisticated investors
14-24 Issuing Securities: The Registration Process Offering process begins with the selection of an investment banker (“underwriter”) Underwriter provides marketing information and directs the distribution of the securities The underwriting agreement specifies such items as the underwriter’s responsibilities and the final disposition of any unsold securities
14-25 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
14-26 Issuing Securities: The Registration Process The Registration Statement Form S-1 has two different levels of disclosure Part I: “Prospectus,” is intended primarily for investors Part II includes more detailed information The 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
14-27 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
14-28 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 (a red herring prospectus), which provides tentative information to investors about an upcoming issue
14-29 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
14-30 Issuing Securities: The Registration Process 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
14-31 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
14-32 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. 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.
14-34 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, and Form 8-K
14-35 Periodic Reporting Requirements Form 10-K is the annual filing to the SEC “Accelerated filers” 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
14-36 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
14-37 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
14-38 Periodic Reporting Requirements Form 10-Q has two parts Part I includes comparative financial statements prepared in accordance with APB 28 Part II is an update on significant matters occurring since the last quarter 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”
14-39 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
14-40 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 are provided with due diligence defences
14-41 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. 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.
14-43 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 bribes Part II requires publicly held companies to maintain an adequate system of internal control and accurate records
14-44 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
14-45 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
14-46 Practice Quiz Question #4 Which of the following statements is NOT true about management reporting laws? a.The Foreign Corrupt Practices Act of 1977 (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. Which of the following statements is NOT true about management reporting laws? a.The Foreign Corrupt Practices Act of 1977 (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.
14-48 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 The items now required in the MD&A are: liquidity, capital resources, results of operations, off-balance sheet arrangements, tabular disclosure of contractual obligations
14-49 Disclosure Requirements Pro forma disclosures Essentially “what-if ” financial presentations often taking the form of summarized financial statements They 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
14-50 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. 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.