© The McGraw-Hill Companies, Inc., 2004 Slide 12-1 McGraw-Hill/Irwin Chapter Twelve Financial Reporting and the Securities and Exchange Commission

© The McGraw-Hill Companies, Inc., 2004 Slide 12-2 McGraw-Hill/Irwin 5 commissioners appointed by the President. Commissioners serve 5-year, staggered terms. Established by the Securities Exchange Act of Only 3 of 5 can come from the same political party. The chairperson is from the same political party as the President. SEC Securities and Exchange Commission (SEC)

© The McGraw-Hill Companies, Inc., 2004 Slide 12-3 McGraw-Hill/Irwin Division of Market Regulation Division of Enforcement Division of Investment Management Office of Compliance Inspections and Examinations Division of Corporate Finance SEC Office of Information Technology Office of the Chief Accountant

© The McGraw-Hill Companies, Inc., 2004 Slide 12-4 McGraw-Hill/Irwin Securities Exchange Act of 1934 Securities Act of 1933 Federal Securities Laws 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 The Stock Market Crash of 1929 …..led to the……

© The McGraw-Hill Companies, Inc., 2004 Slide 12-5 McGraw-Hill/Irwin Goals of the SEC   To ensure full & fair disclosure to all investors.   To prohibit dissemination of materially misstated information.   To prevent misuse of information by inside parties.   To regulate the operation of securities markets.

© The McGraw-Hill Companies, Inc., 2004 Slide 12-6 McGraw-Hill/Irwin Securities Exchange Act of 1934 Securities Act of 1933 Public Utility Holding Company Act of 1935 Full and Fair Disclosure Requires continuous reporting by publicly traded companies. New securities must be registered prior to public sale. Requires registration of interstate holding companies of public utilities. Prohibits fraudulent and unfair behavior.

© The McGraw-Hill Companies, Inc., 2004 Slide 12-7 McGraw-Hill/Irwin Trust Indenture Act of 1939 Requires registration of indentures related to public issue of bonds, notes, etc. Investment Company Act of 1940 Requires registration of investment companies. Investment Advisers Act of 1940 and Securities Investor Protection Act of 1970 Requires registration of investment advisors and requires them to follow certain standards. Full and Fair Disclosure

© The McGraw-Hill Companies, Inc., 2004 Slide 12-8 McGraw-Hill/Irwin Foreign Corrupt Practices Act of 1977 Amends Securities Exchange Act of Requires maintenance of accounting records and adequate internal accounting controls. Insider Trader Sanctions Act of 1984 & Insider Trader and Securities Fraud Enforcement Act of 1988 Increase penalties against persons who profit from illegal use of inside information. Full and Fair Disclosure

© The McGraw-Hill Companies, Inc., 2004 Slide 12-9 McGraw-Hill/Irwin Sarbanes-Oxley Act of 2002 Designed as a response and answer to the numerous corporate accounting scandals that came to light in 2001 and Full and Fair Disclosure

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin In addition to audited financial statements, Rule 14c-3 of the 1934 Act requires the following: The SEC’s Impact on Financial Reporting 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 on the last 2 years. Restrictions on the company’s ability to pay dividends. MD&A 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 on the last 2 years. Restrictions on the company’s ability to pay dividends. MD&A

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Certain information about the auditor must also be disclosed. The SEC’s Impact on Financial Reporting All non-audit services provided by the independent auditing firm. Whether the Board of Directors approved all non-audit services and considered whether they would impair the auditor’s independence. The % of non-audit fees to the total annual audit fee. Individual non-audit fees > 3% of the annual audit fee. All non-audit services provided by the independent auditing firm. Whether the Board of Directors approved all non-audit services and considered whether they would impair the auditor’s independence. The % of non-audit fees to the total annual audit fee. Individual non-audit fees > 3% of the annual audit fee.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Creation of Public Company Accounting Oversight Board Sarbanes-Oxley Act of 2002 Section 101 Board charged with: Establishing auditing, quality control, and independence standards. Performing periodic inspections of registered public accounting firms. Could have potentially replaced the Auditing Standards Board of the AICPA. Board charged with: Establishing auditing, quality control, and independence standards. Performing periodic inspections of registered public accounting firms. Could have potentially replaced the Auditing Standards Board of the AICPA.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Creation of Public Company Accounting Oversight Board Sarbanes-Oxley Act of 2002 Section 101 Five members 2 of the 5 must be or have been CPAs. 2 of the 5 must be or have been CPAs. Remaining 3 must NOT be CPAs. Remaining 3 must NOT be CPAs. The Board will be funded through mandatory fees. The Board will be funded through mandatory fees.Funding Accounting firms must register with the Board and pay fees. Applies to foreign firms as well. Five members 2 of the 5 must be or have been CPAs. 2 of the 5 must be or have been CPAs. Remaining 3 must NOT be CPAs. Remaining 3 must NOT be CPAs. The Board will be funded through mandatory fees. The Board will be funded through mandatory fees.Funding Accounting firms must register with the Board and pay fees. Applies to foreign firms as well.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin To ensure future independence of audit firms, some previously common concurrent services are now prohibited. Sarbanes-Oxley Act of 2002 Auditor Independence 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. 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.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Audit Committees will also be expected to exercise more oversight in the future. Sarbanes-Oxley Act of 2002 Audit Committees Financial Experts on the BOD must be identified in the annual report. 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 Committee hires the external auditor.  The auditor now reports to the Committee instead of to management. Financial Experts on the BOD must be identified in the annual report. 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 Committee hires the external auditor.  The auditor now reports to the Committee instead of to management.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin SEC Requirements

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Congress has assigned GAAP- setting authority to the SEC. The SEC allows the FASB to set GAAP. The FASB’s standards can always be (and was once) overridden by the SEC. (See Oil & GAS – best efforts) Authority only extends to publicly traded companies. The SEC’s Authority Over GAAP

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin 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. The SEC’s Authority Over GAAP

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Filings with the SEC Two basic categories of filings Registration Statements Periodic Filings

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Common SEC Registration Statement Forms

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Registration Process Registration Statements delivered to SEC Review by Div. Of Corp. Finance Deficiency letter sent to registrant Approved after deficiencies are cleared Once the registration is effective, the securities can be sold. Note: This process is both time- consuming and expen$ive.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin General contents of SEC registration reports. Registration Requirements PART I Audited financial Statements. An explanation of the use of the proceeds. A description of the security risks. A description of the business. PART I Audited financial Statements. An explanation of the use of the proceeds. A description of the security risks. A description of the business. PART II Used by the SEC staff. Includes additional information about the company. PART II Used by the SEC staff. Includes additional information about the company.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Offerings Exempt from SEC Filing Securities issued by governments, banks, and S&L’s Securities issued that are restricted to a company’s own existing shareholders. Offerings < $5 million Offerings < $1 million made to 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.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Form 10-Q Quarterly report filed within 45 days of end of quarter. Financial statement are un-audited. Quarterly report filed within 45 days of end of quarter. Financial statement are un-audited. Form 10-K Annual report filed within 90 days of fiscal year-end. Includes audited financial statements. Annual report filed within 90 days of fiscal year-end. Includes audited financial statements. Form 8-K Used to disclose a unique or significant happening. Periodic Filings with the SEC

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Proxy Statements 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) 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)

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin That was fun! Can we do it again? End of Chapter 12