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CHAPTER 12
FINANCIAL REPORTING AND THE SECURITIES AND
EXCHANGE COMMISSION
Chapter Outline
I. In the United States, the Securities and Exchange Commission (SEC), created by Act of
Congress, is responsible for ensuring that complete and reliable information concerning
publicly traded securities is available to investors.
A. Although the SEC regulates requirements created by many legislative acts, the most
significant are the Securities Act of 1933, the Securities Exchange Act of 1934, and the
Sarbanes-Oxley Act of 2002.
B. The SEC has sought to accomplish its objectives by working to achieve several goals
that include:
1. Assuring adequate disclosure of data before securities can be bought and sold,
2. Preventing the misuse of information by inside parties,
3. Regulating the operation of stock exchanges and other securities markets, and
4. Prohibiting the dissemination of materially misstated information.
C. Disclosure requirements of the SEC are contained primarily in two sets of regulations:
1. Regulation S-K establishes rules for all nonfinancial information, such as
management’s discussion of the issuer’s business activities.
2. Regulation S-X prescribes the form and content of the financial statements that are
included in the various SEC filings.
D. The ability to establish disclosure requirements gives the SEC the ultimate authority for
accounting principles in this country, although it has generally allowed the FASB to set
official guidance.
E. The SEC's integrated disclosure system requires that most information that is reported to
the SEC must also go to the company's stockholders at various times throughout the
year.
II. As a direct result of the corporate accounting scandals exposed in 2001 and 2002,
Congress passed the Sarbanes-Oxley Act of 2002. This legislation has had a wide-
ranging impact on corporate financial reporting and the accounting profession as a
whole.
A. One of the most important results of this act is the creation of the Public Company
Accounting Oversight Board.
1. This five-member board is appointed by the SEC and funded by fees assessed
against publicly traded companies.
2. The board has been given the authority to enforce auditing, quality control, and
independence standards. Such power reduces the accounting profession’s ability to
regulate itself as it has done in the past seven decades.
B. All accounting firms that audit companies with securities that are publicly traded must
register with the Public Company Accounting Oversight Board.
1. This registration process allows the new board to gather considerable information
from the public accounting firms.
2. All registered firms are subject to inspection by the Public Company Accounting
Oversight Board as often as each year.
C. The Sarbanes-Oxley Act eliminates a number of consulting services that an accounting
firm can perform for an audit client. The goal of this approach is to strengthen the
independence of the auditing profession.
D. 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 the management. The
audit committee is now responsible for the appointment and compensation of the
independent auditors.
E. Due to additional financial scandals, Congress supplemented Sarbanes-Oxley with The
Wall Street Reform and Consumer Protection Act of 2010 to expand the federal
government’s role in regulating corporate governance.
III. Several methods can be used by the SEC to affect generally accepted accounting
principles in the United States.
A. Additional disclosure requirements.
B. Moratorium on specific accounting practices.
C. Challenging individual statements and other reporting by companies filing with the SEC.
D. Overruling the FASB (as shown by the rejection of SFAS 19).
IV. Companies that offer securities for sale to the public must meet a number of filing
requirements monitored by the SEC.
A. Registration statements are required prior to the issuance of any new security.
1. Depending on specific circumstances, specified forms are required for this purpose
(including Forms S-1 and S-3).
2. After completing the appropriate registration form, a company will normally receive a
letter of comments from the SEC requesting changes and/or additional disclosures
that the SEC deems necessary.
3. Unless exempt from registration, securities cannot be sold until the registration
statement is made effective by the SEC.
B. 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:
1. Form 10-K is an annual report presenting the company's activities and financial
position.
2. Form 10-Q contains condensed interim financial statements.
3. Form 8-K discloses the occurrence of a unique or significant happening.
4. A proxy statement (Form 14A) solicits voting power to be used at stockholders'
meetings.
V. 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 and contains extensive
information and documentation relating to practically every publicly traded security.
Answer to Discussion Question
Is the Disclosure Worth the Cost?
No ultimate answer exists to the question of how the SEC should weigh the costs of disclosure
versus the need for adequate information. Students often feel that the importance of the work of
This discussion question is intended to show the high cost to the American economy of ensuring
that adequate and fair information is available. The $400 million estimation that was made in
1975 (nearly forty (40) years ago) is a staggering figure. It shows this concern has existed for
One method of approaching this question is to ask students to envision what would result if the
SEC was simply to be dissolved. How would companies entice investors into contributing
funds? What methods would companies invent to provide assurance to investors? Would more
Once the benefits of having an authority like the SEC are established, how should these
benefits be weighed against the cost of disclosure? Although $400 million (which was the
made of this question, it should provide for a good deal of class discussion.
Answers to Questions
1. Many of the federal securities laws were passed initially in hopes of putting an end to
abuses that were present in securities trading. These problems were first brought to the
2. The corporate accounting scandals of this period took several forms. Some were based on
manipulating loopholes in generally accepted accounting principles to allow companies to
avoid adequately disclosing risky ventures. Others were simply fraudulent reporting of
3. The Sarbanes-Oxley Act has numerous provisions, almost all of which are designed in one
way or another to restore public confidence. Several of those provisions include:
A Public Company Accounting Oversight Board has been created to enforce and
regulate auditing, quality control, and independence standards.
All accounting firms that audit publicly-held issuers of securities must register with the
Oversight Board and provide detailed information about their operations.
4. The Sarbanes-Oxley Act gives the SEC the power and responsibility to oversee the work of
5. According to the Sarbanes-Oxley Act, accounting firms are only required to register with the
6. Registration with the PCAOB forces the accounting firm to (a) provide a significant amount
7. The Sarbanes-Oxley Act gives the Public Company Accounting Oversight Board authority
over auditing independence rules. Therefore, all future changes made by this body will be
8. Prior to the Sarbanes-Oxley Act, most accounting firms were required to undergo periodic
peer reviews of their audit documentation and their quality control procedures. However,
those reviews were largely done by one firm on another and, given the accounting scandals
9. "Regulation S-K" establishes disclosure and other reporting requirements for the
nonfinancial information that is contained in filings with the SEC.
11. The Securities and Exchange Commission is composed of more than two dozen divisions
and major offices. Some of these include the following:
— Division of Corporation Finance—ensures that standards for reporting and disclosure are
followed.
12. The Securities Act of 1933 regulates the initial offering of securities by a company or its
13. The Securities Exchange Act of 1934 regulates the subsequent buying and selling of
14. The goals of the SEC are many. However, several prominent goals are as follows:
— Ensuring that full and fair information is disclosed to all investors before securities can be
exchanged.
15. Information to be included in proxy solicitation material includes the following data:
— Five-year summary of operations including sales, total assets, income from continuing
operations, and cash dividends per share.
— Description of business activities.
— Three-year summary of industry segments, export sales, and foreign and domestic
operations.
16. A proxy statement is a request made to stockholders for the right to cast their votes at
17. Any change made by the SEC in its Regulation S-X, the financial reporting regulation, will
have a direct impact on the form and content of the financial reporting of the publicly-held
companies in this country. Thus, the Commission has the ability to dictate generally
18. Financial Reporting Releases are issued by the SEC to explain desired changes in reporting
19. Prior to 1977, the SEC had restricted the use of its accounting authority primarily to
disclosure requirements and areas of financial reporting where authoritative guidance was
not available. The FASB (and its predecessors in the private sector) had been allowed to
establish generally accepted accounting principles in the U.S. The setting of accounting
20. Registration statements are designed to disclose and make available adequate relevant
21. Disclosure of sufficient information – Registration Statement disclosure - is required by the
Securities Act of 1933.
22. Part I of a registration statement is called a prospectus and must be furnished to every
potential buyer of the securities to be issued. It contains information such as financial
23. Revenues are raised by the SEC, in part, through a registration fee for shares being initially
issued. In 2013, this fee was $136.40 for each $1 million of security offering.
24. In the filing of registration statements, a number of different forms are available depending
upon the circumstances. Of these forms, these two are especially common:
— Form S-1 which is used by new registrants or by companies that have filed with the SEC
for less than 36 months;
25. Incorporation by reference is a process allowed when preparing filings with the SEC, and
often other governmental agencies. It is intended to reduce the quantity of redundant
26. A pre-filing conference is a meeting between a prospective registrant and the staff of the
SEC in hopes of resolving potential problems that may be expected to arise in an upcoming
27. A letter of comments (which is also known as a "deficiency letter") is issued by the SEC to a
28. A prospectus is the first part of a registration statement, the portion that has to be furnished
to every potential buyer of a new security. The prospectus discloses a significant amount of
29. Certain new security issues are exempt from the registration requirements monitored by the
SEC. For example, securities sold within a single state are normally not subject to these
federal laws. In addition, the securities of banks, savings and loan associations, and
governments do not come under the Securities Act of 1933. Several other offerings are also
exempt from completing formal registration statements although other legal filings may be
required:
30. Private placements of securities have become extremely popular in recent years because
they are exempt from the registration requirements of the SEC. The securities are issued to
31. Blue sky laws are securities laws enforced by individual states. In contrast to federal
securities laws, blue sky laws usually apply only to sales that are restricted to a particular
state.
32. A wraparound filing is one in which a company uses its annual report to shareholders to
33. Form 8-K is not issued on a regular basis but only when disclosure of a unique or significant
occurrence is to be made. Thus, a company has some choice as to the necessity of issuing
a Form 8-K. The SEC does, however, list several events that require disclosure in this
34. The Management's Discussion and Analysis (MD&A) is a narrative description of the
company's past, its present, and its future. The management describes its priorities,
35. The Form 10-K is an annual report (financial statements and related information) whereas
the Form 10-Q contains condensed interim financial statements and is filed quarterly.
