CHPT 16

Chapter 16
The SEC and

Financial Reporting
Cambridge Business Publishers, ©2016

Objectives
1. Discuss why the SEC was established and the principal

legislation it enforces
2. Examine the SEC’s organization and structure
3. Describe principal SEC requirements for registering new
securities
4. Explain the periodic reporting requirements for SEC
registrants
5. Describe the SEC’s role in corporate accountability and
governance
6. Explain the SEC’s role in accounting standards
development and global standards convergence
Think about it
1. What do you know about the SEC?

2. Why should you care?
3. Why is the SEC important to an accounting
professional?

Introduction
 SEC has statutory authority to

 Set accounting principles
 Regulate securities markets
 Compliance with SEC regulations requires specialized
expertise
 SEC’s full disclosure mission
 Provide capital markets with all material information about
public companies
 Companies listed on U.S. stock exchanges subject to extensive
requirements
 Affect responsibilities of professional accountants
Introduction
continued
 SEC action to increase regulation triggered by events

with harmful impacts on investors and economy
 Perceived weaknesses of self-regulation led Congress to
enact
 Sarbanes-Oxley Act 0f 2002
 Dodd-Frank Wall Street Reform and Consumer Protection Act
of 2010

Take a field trip
Go to SEC.gov
Explore the information on the SEC’s website.
You should find all of this information

Learning Objective 1
Discuss why the SEC

was established and the
principal legislation it enforces.

Establishment of the SEC
 Established by the Securities Exchange Act of 1934

 Conceived during the worst financial and social crisis in
history
 Became part of a much broader program of social
reform in the face of massive economic problems from
1929-1932, including
 High unemployment
 Bank failures
 Foreclosures
 Decline of GNP
Mission of SEC
 Administer federal legislation promoting efficient capital

allocation by ensuring that securities markets function
fairly and honestly, through
 Protection of investors by requiring full disclosure of material
information by issuers of securities, and
 Prevention of fraudulent activities in securities trading and
markets
 Charged with administering numerous federal securities
laws

Federal Securities Laws
Administered by the SEC
1933 Securities Act
1934 Securities Exchange Act
1935 Public Utility Holding Company Act
1939 Trust Indenture Act
1940 Investment Company Act
1940 Investment Advisers Act
1970 Securities Investor Protection Act

Federal Securities Laws
Administered by the SEC
continued
1977 Foreign Corrupt Practices Act
1984 Insider Trading Sanctions Act
1995 Private Securities Litigation Reform Act
2002 Sarbanes-Oxley Act
2008 Emergency Economic Stabilization Act
Dodd-Frank Wall Street Reform and

2010 Consumer Protection Act
Securities Act of 1933
 Deals primarily with the issuance of new securities

 Regulates the public offering of securities
 Prohibits (subject to certain exemptions) the offering
and sale of securities unless they are registered with
the government
 Prohibits fraudulent or deceptive practices in the
offering or sale of securities

Securities Exchange Act of 1934
 Established the Securities and Exchange Commission

 Granted the SEC jurisdiction over the securities markets
 Governs trading in securities once issued and
outstanding
 Authorizes the government, through the SEC, to
establish accounting, reporting, and disclosure
requirements for publicly-owned corporations
 Prohibits deceptive and manipulative practices in the
purchase or sale of securities
Sarbanes-Oxley Act of 2002 (SOX)
 Created by Congress in wake of several financial

reporting scandals and corporate governance failures in
early years of 21st century
 Requires
 Reports on internal controls
 Top management certifications of financial statements filed
with the SEC
 Created the Public Company Accounting Oversight Board
(PCAOB)
 Monitors auditing firms
 Sets auditing standards
Emergency Economic Stabilization Act
of 2008
 Allowed government to “bail out”

 Banks holding subprime mortgages
 Other organizations (e.g., General Motors)
 Reminds the SEC of ability to suspend or modify
accounting standards
 FASB’s mark-to-market fair value accounting rules
 Some believe 2008 financial crisis worsened by requiring banks to
book large losses on securities when markets became inactive
 FASB later issued additional guidance relaxing some strict mark-to-
market interpretations

Dodd-Frank Wall Street Reform
and Consumer Protection Act of 2010
 Also related to the 2008 financial crisis

 Substantially expanded the SEC’s role in monitoring
financial services markets

Definition of a Security
Security, as defined by the Securities Act of 1933 (Sec. 2.1)

Exempt Securities
Securities exempt from SEC regulations and reporting rules:

 Securities issued or guaranteed by federal, state, or local
governments
 Securities issued or guaranteed by a bank or savings and
loan association
 Subject to provisions of the 1934 Act
 Commercial paper/short-term notes (original maturity
< 9 mos.) issued for working capital purposes
 Securities issue by not-for-profit organizations
 Subject to provisions of the 1934 Act
Examine the SEC’s

organization and structure.

Structure of the SEC
 The commission consists of five commissioners

 Nominated by U.S. President and confirmed by Senate
 One nominated each year for staggered 5-year terms
 No more than 3 of 5 from President’s political party
 Nonpartisan agency independent from legislative and
executive branches of government
 Funded by combination of user charges and
congressional appropriations
 Support staff including accountants, attorneys,
economists, IT specialists, etc.
Take a field trip
 Did you find the Commissioners?

 Who is the Chair?
 Did you read any of the bios of the commissioners?

Divisions of the SEC
Division of Corporation Finance
Division of Enforcement
Division of Trading and Markets
Division of Investment Management
Division of Economic and Risk Analysis

Take a field trip
1. Go to the SEC’s website

2. Review the role and goals of each of the Divisions
3. Write a brief sentence or two to summarize each
Division
4. As an accounting professional we should know about

our regulating body

SEC Pronouncements on Accounting and
Auditing
 SEC generally delegates its authority to set accounting

principles to FASB
 However, SEC
 May impose additional requirements on its registrants
 May ask FASB to deal with specific accounting issues
 Frequently comments on accounting and auditing matters
 SEC communicates its views on accounting and auditing-
related matters via
 Formal published pronouncements
 Less formal methods
SEC Communication on Accounting and
Auditing—Formal SEC Pronouncements
Financial Reporting Releases (FRR)
 Somewhat analogous to FASB Codification

 Highest-ranking authoritative source of accounting principles for publicly-
held companies
Staff Accounting Bulletins (SAB)
 Similar but not identical to FASB Technical Bulletins

 Issued by SEC staff, including the Chief Accountant, without due process,
and without a vote by commission
 Represent staff’s current position on various accounting issues in SEC filings
Auditing—Formal SEC Pronouncements
continued
Accounting and Auditing Enforcement Releases (AAER)
 Report disciplinary or other enforcement actions against accountants and

others whose conduct affects public companies’ financial reporting
 Require an affirmative vote by the SEC commissioners

Auditing—Informal SEC Communication
Private Rulings
 Issued to companies concerning particular transactions

 Referred to as no-action and interpretive letters
 Indicate that the SEC will not object if a transaction is handled in the
proposed manner
Informal Statements
 Issued by commissioners or top staff in speeches or written releases

 Informally convey views of key individuals on certain matters
 Frequently used to express views on matters being considered by the FASB
or by the accounting profession
Describe principal SEC requirements

for registering new securities.

Securities Act of 1933
 Sets requirements for registration of new security

issues
 Full disclosure requirement
 Provides adequate and accurate disclosure of material facts
concerning the company and the securities it proposes to
sell
 With few exemptions, no security may be offered or
sold to the public unless it is registered with the SEC
Registration means disclosure requirements are satisfied
(compliance review, not merit review).

Filing under the Securities Act of 1933
 Prospective issuer must file a registration statement

 Set of documents needed to register securities
 Consists of two parts
 Prospectus—must be furnished to each purchaser of the security
 Other information and exhibits that must be publicly available, but
need not be supplied to each investor
 Prospectus describes
 Issuing company
 Business operations and risks Typically prepared by a
 Financial statements registration team consisting
of issuer’s CFO, legal counsel,
 Historical financial information underwriter, and
 Securities to be sold underwriter’s counsel.
 Expected uses of the proceeds
Registration Statement
 Reviewed by Division of Corporation Finance

 Issuing company may receive a letter of comment
stating any suggestions or criticisms
 Preliminary prospectus
 Distributed by companies to investors to promote securities
before the registration statement is effective
 “Preliminary Prospectus” stamped in red on the cover
 Known as a “red herring”
 Changes often made after SEC review
 Once effective, issuer may sell securities to the public
Registration Forms
Form S-1
 Basic form for the registration of new issues
 Consists of lists of required disclosures
Form S-3
 Short form
 Used by issuers meeting specific criteria
Form S-4
 Used for securities issued in exchanges
 Commonly used for business combinations
Financial Data in Registration Statements
 Balance sheet dated within 90 days of filing

 Statements of comprehensive income and statements of
cash flows for past three years
 Summaries of operations for past five years
 Auditor’s report covering at least through the end of the
last fiscal year
 Accountant’s review generally covers period from the last
audited statement to the ending date of the most recent
interim period, a.k.a., the stub period
Commonly, comfort letters written by accountants to the underwriter provide negative
assurance on nonfinancial statement information contained in registration statement.
Exemptions
to the Registration Requirements
 “Small” offerings
 Limits on maximum dollar size and number of investors
allowed
 Private placements
 Securities issued to a single investor or small group of
investors who have access to the kind of information
otherwise disclosed during registration
 Often institutional investors such as insurance companies and
pension funds

Trading in the Market
 After registration and sale

 Securities normally trade in a secondary market
 Trading possibilities
 Over-the-counter by dealers
 Listed and traded on one of the organized securities
exchanges
 Issuing company has continuing obligation
 To provide full and complete disclosure of relevant
information
 To satisfy the SEC’s periodic reporting requirements
Explain the periodic reporting

requirements for SEC registrants.

Securities Exchange Act of 1934
 Subjects issuers of traded securities to same “full

disclosure” philosophy that 1933 Act applies to new
offerings
 Periodic reporting requirements of the SEC apply to
 All companies having securities listed on a national securities
exchange
 All companies having more than 500 stockholders, and more
than $10 million in assets

EDGAR
 Electronic Data Gathering, Analysis, and Retrieval System

 Online availability of most documents filed with the SEC
 Allows users to search for filing information
 By company name, country, most recent filing, filing type, etc.
 Most documents available in multiple formats
 Many documents filed in Interactive Data format using
eXtensible Business Reporting Language (XBRL)
 Codes financial statement data
 Allows users to download selected data directly to spreadsheets

Take a field trip
 Can I access EDGAR? Absolutely

 Go to the SEC’s website

Principal Reports to the SEC
 Annual report (Form 10-K)

 Quarterly reports (Form 10-Q)
 Special reports (Form 8-K)
 Filed after specified events occur
 Content of reports governed by
 Regulation S-X—accounting and financial statement
requirements for annual and quarterly reports
 Regulation S-K—all other disclosures

Take a field trip
• Find the filings for a company.

• Try Pepsico
• Can you find the 10-K, 10-Q, any 8-Ks? What else?
• Explore their filings and see what you find.
Annual Report
Form 10-K
 An extensive document presenting financial statements

and a variety of disclosures and descriptive information
 To standardize reporting, a company’s annual report to
stockholders must conform to SEC financial statement
requirements in Regulation S-X
 SEC specifies that other SEC-required disclosures be included
in the annual report to stockholders
 Such information can be incorporated into the 10-K by
reference to the annual report to shareholders

10-K SEC Filing Deadlines
Filing deadlines depend on the market capitalization

(public float) of the filer.

Management Responsibility
 Signify broad responsibility of officers and directors for

proper reporting and disclosure
 10-K signatures required
 Principal executive officer
 Principal financial officer
 Principal accounting officer
 Majority of the board of directors
 Section 302 of Sarbanes-Oxley Act
 Requires that CEO and CFO certify accuracy and completeness
of company’s financial reports with personal sworn statements
 SOX Section 404
 Requires certification of adequacy of internal controls in general
and “internal control over financial reporting” in particular
Structure and Content of Form 10-K

Form 10-K Item Content
continued
Certifications
 Emphasize responsibility of top management for the
veracity of company’s financial reports
 Required by SEC, and SOX Sections 302 and 404
 Personal sworn statements by registrant’s CEO and CFO
1. Accuracy and completeness of financial statements
2. Effectiveness of internal controls/procedures on financial reporting
3. Deficiencies in and changes to internal controls, including corrective
actions
 SOX, Section 302(a)(3) requires CEO and CFO to certify
annual/quarterly reports fairly present company results
of operation and financial condition
Regulation S-X
 Governs form and content of financial reporting to SEC

 Collection of rules derived from original SEC
pronouncements
 Part of the prescribed body of accounting and reporting
principles to be followed in SEC filings
Accounting and reporting
principles for SEC filings
FASB pronouncements Regulation S-X

Regulation S-X
SEC Accounting Rules vs. FASB
 Section 101 in SEC’s Codification of Financial Reporting

Policies endorses the work of FASB
 SEC automatically accepts pronouncements of the FASB
 Unless SEC issues own pronouncement on particular subject
 SEC has statutory authority to set accounting principles
 SOX, Section 108 authorizes SEC to recognize as generally
accepted, any accounting principles established by a
standard-setting body that meets the Act’s requirements
FASB is the SEC’s “official” accounting standard-setter, but SOX leaves room for
the SEC to recognize the work of other standard-setters, such as the IASB.
Regulation S-X
Article 3
Financial Statements and Time Periods
 Prescribed by Article 3 of Regulation S-X; registrants

must provide
 Audited consolidated balance sheets as of the end of the
two most recent fiscal years
 Audited consolidated statements of income and
comprehensive income and cash flows for the three most
recent fiscal years
 Analysis of changes in stockholders’ equity accounts, shown
in balance sheet for three most recent fiscal years (as a
separate financial statement or footnote schedule)

Regulation S-X
Article 4
Requirements for Foreign Private Issuers
 Non-U.S. companies whose stock is listed on U.S.

exchanges
 Annual report, Form 20-F, filed with the SEC
 Companies using full IFRS are not required to reconcile
to U.S. GAAP
 Companies not using U.S. GAAP or full IFRS
 May file financial statements prepared using other standards
 However, must present a reconciliation of net income and
stockholders’ equity to U.S. GAAP

Regulation S-X
Article 4
Notes to the Financial Statements
 Must provide
 Summarized balance sheet and income statement information
for certain significant unconsolidated subsidiaries and equity
method investees
 Reconciliation of reported income tax expense to income tax
expense based on the statutory federal tax rate
 Aids in understanding reasons for the difference between statutory
rate and effective tax rate
 Information on significant transactions with related parties
 Encompasses provisions set forth in
 ASC Topic 850
 Statement on Auditing Standards No. 6
Regulation S-X
Article 4, Notes to Financial Statements
continued
 Required disclosures when separate financial statements

are prepared for the registrant or certain investees and
subsidiaries
 Amounts eliminated and not eliminated in the related
consolidated statements
 Effect of intercompany profits/losses not eliminated in the
separate statements
 Material related party items must also be identified on
face of the respective financial statement

Quarterly Report
Form 10-Q
 Intended to provide an update of most recently filed

10-K report
 Provides timely disclosure of important developments
 Must be filed within 45 days after end of each of first
three fiscal quarters
 Within 40 days for large accelerated and accelerated filers
 Data need not be audited
 Must be at least reviewed by the independent accountants

Quarterly Report
Form 10-Q
Contents
 Balance sheets
 At end of quarter, and
 At end of prior fiscal year
 Quarterly and year-to-date statements of income and
comprehensive income
 For current quarter, and
 Same quarter of prior year
 Cumulative year-to-date statements of cash flow
 For the current fiscal year, and
 Prior fiscal year
Special Reports
Form 8-K
 Must be filed within four days of the occurrence of

events significant to investors
 Decision to file is often a matter of judgment
 Especially for events reported under Item 8.01, Other events
 Example: Target Corporation’s data breach in late 2013
 8-K issued in early 2014 identifying breach as one of many risk
factors
 Financial statements not usually included
 Exception: If event is a major acquisition
 Acquired company’s financial statements are included

Special Reports
Examples of events included on
Form 8-K
Form 8-K:

Describe the SEC’s role

in corporate accountability
and governance.

Corporate Accountability
 How a corporation conducts its affairs and relates to its

security holders, employees, and the public
 SEC involved in setting guidelines for corporate
governance
 Examples of accountability and governance related
regulations include:
 Foreign Corrupt Practices Act of 1978
 Sarbanes Oxley Act 2002
 Dodd Frank Act 2010

Do you know about any of these acts?
 What do you know about these acts?

 Foreign Corrupt Practices Act of 1978
 Sarbanes Oxley Act 2002
 Dodd Frank Act 2010
 How are they related to corporate accountability and
corporate governance?

Proxy Statements
 Communication to shareholders of matters for

shareholder action, including:
 Election of directors
 Appointment of independent auditor
 Change in corporate charter or bylaws
 Issuance of new securities
 Approval of a business combination

Proxy Statements
continued
 Discusses matters and advises shareholders of voting

procedures
 Provide shareholders with information needed to assign
their voting right (or proxy) if they cannot attend
shareholder meeting
 Provides mechanism for action on stockholder proposals
not supported by management
 Provides detailed information on board committees,
litigation, management compensation plans, and
related-party transactions
Explain the SEC’s role in

accounting standards development
and global standards convergence.

SEC’s Role
in Setting Accounting Standards
 SEC generally delegates statutory standard-setting

authority to FASB
 Actively oversees standard-setting process and reviews
registrants’ filings
 Accepts FASB standards in most cases
 Occasionally influences FASB or imposes its own
standards

SEC Interaction with FASB
 Stock options
 Currently required to be expensed at fair value when granted
 Using appropriate valuation method
 Previously, most companies did not expense stock options
 Standard first proposed by FASB in mid 1990s
 Companies using options as significant form of compensation
concerned it would greatly lower reported income
 Congress thought it would hurt the economy
 SEC influenced FASB to issue weaker standard in 1995
 Made expensing optional
 FASB issued revised standard in 2004 making expensing
mandatory (ASC Topic 718)
continued
 Special purpose entities

 SEC put pressure on FASB after Enron accounting scandal
 Pushed FASB to “fast-track” its consolidating special purpose
entities project
 Guidance emerged quickly (2003)
 ASC Topic 810
 Standard continues to be modified with goal of consolidating
any entity a company controls

continued
 Mark-to-market accounting
 SEC completed Congressionally-mandated study of FASB’s
mark-to-market standards in 2009
 Focus on its application to valuation of financial instruments
 Motivated by concerns over
 Effects of fair value accounting on financial institutions
 Market response to investment write-offs
 SEC study concluded that fair value accounting standards
provide useful information and should not be suspended
 In midst of limited markets due to financial crisis, SEC
persuaded FASB to develop new guidelines
 Valuations using normal market prices
 Helped banks avoid catastrophic write-downs
Convergence of U.S. GAAP and IFRS
 Major ongoing SEC initiative to converge GAAP and IFRS

 In 2008, SEC proposed “roadmap” requiring all U.S.
public companies to file under IFRS in 2014
 Following a phase-in beginning with certain filings in 2010
 After initial enthusiasm, major differences remain
 Example of almost complete convergence
 Accounting for business acquisitions
 Divergence without indication of being near convergence
 Consolidation of SPEs
 Classification of and impairment testing for financial
instruments
The End

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Chapter 16

The SEC and

Cambridge Business Publishers, ©2016

1. Discuss why the SEC was established and the principal

1. What do you know about the SEC?

Cambridge Business Publishers, ©2016

 SEC has statutory authority to

 SEC action to increase regulation triggered by events

Cambridge Business Publishers, ©2016

Cambridge Business Publishers, ©2016

Discuss why the SEC

Cambridge Business Publishers, ©2016

 Established by the Securities Exchange Act of 1934

 Administer federal legislation promoting efficient capital

Cambridge Business Publishers, ©2016

1933 Securities Act

1934 Securities Exchange Act

1935 Public Utility Holding Company Act

1939 Trust Indenture Act

1940 Investment Company Act

1940 Investment Advisers Act

1970 Securities Investor Protection Act

1977 Foreign Corrupt Practices Act

1984 Insider Trading Sanctions Act

1995 Private Securities Litigation Reform Act

2002 Sarbanes-Oxley Act

2008 Emergency Economic Stabilization Act

Dodd-Frank Wall Street Reform and

 Deals primarily with the issuance of new securities

Cambridge Business Publishers, ©2016

 Established the Securities and Exchange Commission

 Created by Congress in wake of several financial

 Allowed government to “bail out”

Cambridge Business Publishers, ©2016

 Also related to the 2008 financial crisis

Cambridge Business Publishers, ©2016

Security, as defined by the Securities Act of 1933 (Sec. 2.1)

Cambridge Business Publishers, ©2016

Securities exempt from SEC regulations and reporting rules:

Examine the SEC’s

Cambridge Business Publishers, ©2016

 The commission consists of five commissioners

 Did you find the Commissioners?

Cambridge Business Publishers, ©2016

Division of Corporation Finance

Division of Trading and Markets

Division of Investment Management

Division of Economic and Risk Analysis

Cambridge Business Publishers, ©2016

1. Go to the SEC’s website

4. As an accounting professional we should know about

Cambridge Business Publishers, ©2016

 SEC generally delegates its authority to set accounting

Financial Reporting Releases (FRR)

 Somewhat analogous to FASB Codification

Staff Accounting Bulletins (SAB)

 Similar but not identical to FASB Technical Bulletins

Accounting and Auditing Enforcement Releases (AAER)

 Report disciplinary or other enforcement actions against accountants and

Cambridge Business Publishers, ©2016

 Issued to companies concerning particular transactions

 Issued by commissioners or top staff in speeches or written releases

Describe principal SEC requirements