Chapter 12

Financial Reporting and the Securities Exchange Commission

The SEC

• In the U.S., the SEC is responsible for ensuring that complete and reliable information concerning publicly traded securities is available to investors.



• Although the SEC regulates requirements created by several legislative acts, the most significant are the Securities Act of 1933 and the Securities Exchange Act of 1934.



• The SEC has sought to accomplish its objectives by working to achieve several goals that include

• Assuring adequate disclosure of data before securities can be bought and sold
• Preventing the misuse of information by inside parties
• Regulating the operation of stock exchanges and other securities markets, and
• Prohibiting the dissemination of materially misstatement information.



• Disclosure requirements of the SEC are contained in two sets of regulations

• Regulation S-K establishes the rules for all nonfinancial information
• Regulation S-X prescribes the form and content of the financial statements that are included in various filings



• The ability to establish disclosure requirements gives the SEC the ultimate authority for accounting principles in this country although it has allowed the FASB to set official guidance.



• The SEC's integrated disclosure system requires that most information that is reported to the SEC must also go to the company's stockholders.

History of Securities Regulation (Not in book)

• 1913/14 - Sixteenth amendment to the constitution, and the passing of the income tax law, the Federal Reserve Act, the Federal Trade Commission Act, and the Clayton Antitrust Act

• Lawyers avoided income taxes as a practice area, so accountants became indispensable in the preparation of individual and corporate tax returns.



• The need for attested financial statements also arose for banks as well as the Federal Reserve banks, because discounted paper was presented to them.



• 1840's to 1920's - In the absence of specific regulations in the US, the emerging accounting profession looked to Britain. This was a result of the British accounting firms establishing footholds in the US (Price Waterhouse, for example) and their British personnel. The British system was based on statutory traditions of uniform systems of accounting & auditing standards leading to a quasi-judicial attitude towards their duties, and on an apprenticeship-based entry into the profession that supported an anti-intellectual tradition. However, subsequent development in accounting in the US reflect emphasis on corporate disclosure, rather than uniformity.



• 1926/27 - Publication of Professor Ripley's articles in the Atlantic Monthly and the publication of his book Main Street and Wall Street. In those works, he attacked then existing abuses in the American financial sector. They included lack of cumulative voting, absence of effective government regulation, non-standardized corporate accounting practices, excessive trading on the equity, denial of pre-emptive rights, selling corporate assets "without let or hindrance." His writing were not really taken seriously by the accounting profession.



• 1929 - On Black Thursday (October 24, 1929), the Times industrial index fell only by 12 points. The following days, however, the market collapsed.



• 1933 (Securities Act) - Often referred to as the "truth in securities" law. Section 11 of the act demolished three common law doctrines that accountants had relied on



• Doctrine of privity - lack of contract giving rise to the duty of an accountant was no longer a factor in the actions brought under this section.
• Doctrine of causality - it was not longer necessary to establish the errors or misstatements in financial statements were the proximate cause of a loss.
• Doctrine of reliance - it was no longer necessary for the plaintiffs to prove reliance on the financial statements or the auditor's report.



• 1934 (Securities Exchange Act) - Also referred to at "investor protection law." This statute covers corporate reporting, proxy solicitations, insider trading, registration of exchanges, broker-dealer registrations.

Organization of the SEC

• SEC is directed by 5 commissioners, no more than three of whom may be from the same political party.

• Members of the commission are appointed by the President with approval of the Senate
• Each commissioner is appointed for a 5-year term



• There are four divisions in the SEC, some of which have overlapping authority



• Division of Corporate Finance -



• Major responsibilities include assisting the Commission in establishing and requiring adherence to standards of economic and financial reporting and disclosure by all companies under the SEC jurisdiction, setting standards for disclosure requirements of proxy solicitations, administering the disclosure requirements of the Securities Act, the Securities Exchange Act, the Public Utility Holding Company Act, and the Investment Company Act

• reviews all registration statement, prospectuses, quarterly and annual reports, proxy statements and sales literature



• Division of Market Regulation



• assists the Commission in the regulation of national securities exchanges and of brokers and dealers registered under the Investment Advisers Act



• Also supervises the broker-dealer inspection program



• Division of Enforcement



• responsible for the review and direction of all enforcement activities of the regional offices, supervision of investigations conducted pursuant to federal securities laws, and the institution of injunctive actions.



• Division of Investment Management Regulation



• assists the SEC in administration of the Investment Company Act and the Investment Advisors Act of 1940.



• There are 3 major offices of the SEC



• Office of the Chief Accountant



• provides the Commission with expert advice in matters of accounting and auditing
• Goal of the chief accountant is to upgrade accounting and auditing standards to provide the disclosure the SEC seeks



• Directs the development of administrative policy concerning accounting matters and the preparation of accounting rules and regulations.

• Office of the General Counsel



• represents the Commission in judicial proceedings



• handles legal matters which cut across the lines of work of several operating divisions



• provides advice and assistance to the SEC, its operating divisions, and regional offices with respect to statutory interpretation, rule making, legislative matters and other legal problems.



• Office of Compliance Inspections and Examinations



• determines whether brokers, dealers, investment companies, and advisers are in compliance with federal securities laws



• Office of Information Technology



• supports the SEC and staff in all aspects of IT



• operates EDGAR

SARBANES OXLEY

• As a direct result of the corporate accounting scandals exposed in 2001 and 2002, Congress passed the Sarbanes-Oxley Act of 2002. This legislation will have a wide-ranging impact on corporate financial reporting and the accounting profession as a whole.



• The Public Company Accounting Oversight Board

• This five-member board will be appointed by the SEC and will be funded by fees assessed on publicly traded companies.
• The board has been given the authority to enforce auditing, quality control, and independence standards. Such power eliminates the accounting profession's ability to regulate itself as it has done in the past.



• All accounting firms that audit companies with securities that are publicly traded must register with the PCAOB

• This registration process allows the new board to gather considerable information from the public accounting firms.
• All registered firms are subject to inspection by the PCAOB as often as each year.



• The Sarbanes-Oxley Act eliminates a number of consulting services that an accounting firm can perform for an audit client.



• The Sarbanes-Oxley Act also requires the audit committee of a company's Board of Directors to be made up of individuals who are independent of management. The audit committee is now responsible for the appointment and compensation of the independent auditors.

GAAP

• Several methods can be used by the SEC to affect GAAP in the United States

• Additional disclosure requirements
• Moratorium on specific accounting practices
• Challenging individual statements and other reporting by companies filing with the SEC
• Overruling the FASB (as shown in the rejection of SFAS No. 19)

Filing Requirements

• Registration statements are required prior to the issuance of any new security

• Depending on specific circumstances, specified forms are required for this purpose (including Form S-1, S-3 and SB-2)
• After completing the appropriate registration form, a company will receive a letter of comments from the SEEC indicating changes or explanations that are requested.
• Securities cannot be sold until the registration statement is made effective by the SEC



• Companies that have their securities publicly traded on an exchange must also make regular periodic filings with the SEC. Some of the most common of these disclosure documents are

• Form 10-K is an annual report presenting the company's activities and financial position.
• Form 10-Q contains condensed interim financial statements.
• Form 8-K discloses the occurrence of a unique or significant happening.
• A proxy statement solicits voting power to be used at a stockholders' meeting.



• The SEC has developed a system that allows investors to gain access to filed information electronically over the Internet. This system is known as EDGAR.