Congress created the Securities and Exchange Commission (SEC, or the Commission) through the Securities Exchange Act of 1934 (the 1934 Act). The Securities Act of 1933 (the 1933 Act) was administered by the Federal Trade Commission before the SEC was established.

The 1933 Act and 1934 Act (the Securities Acts) are the main securities statutes of importance to accountants. The Commission also administers the Public Utility Holding Company Act of 1935, the Trust Indenture Act of 1939, the Investment Company Act of 1940, and the Investment Advisers Act of 1940. In addition, the Commission administers the Securities Investor Act of 1970 and also serves as adviser to the U.S. District Court in connection with Federal Bankruptcy Act reorganization proceedings involving registrants. More recently, the Sarbanes-Oxley Act of 2002 has provided additional rules and regulations for publicly traded companies, their management, board members and advisers. The SEC's Web site is www.sec.gov.

(b) Organization of the Securities and Exchange Commission

The Commission is an independent agency of five commissioners. No more than three may be of the same political party. They are appointed by the President of the United States (with advice and consent of the Senate) to five-year terms, one term expiring in June of each year.

One commissioner is designated by the President as chair of the Commission. The Commission has a professional staff, consisting of lawyers, accountants, engineers, financial analysts, economists, and administrative and clerical employees, which is organized into 23 divisions and offices including administrative offices. Descriptions of the 11 key nonadministrative divisions and offices and their responsibilities are presented next:

1. Office of International Affairs. Primarily responsible for negotiating understandings between the SEC and foreign securities regulators and for coordinating enforcement programs pursuant to those agreements. It also consults with other divisions and offices concerning the effect of the internationalization of the securities markets on their responsibilities and programs and works as a liaison to emerging markets around the world

2. Division of Trading and Markets. Regulates and oversees securities exchanges, national securities associations, and brokers-dealers, and administers the statistical functions.

3. Division of Enforcement. Supervises enforcement activities under the statutes administered by the Commission and institutes civil and administrative actions. The division works with law enforcement agencies in the United States and around the world to initiate criminal cases as appropriate.

4. Division of Investment Management. Administers the Investment Company Act of 1940, the Investment Advisers Act of 1940, and the Public Utility Holding Company Act of 1935 by reviewing investment company and investment adviser filings, assisting with enforcement matters involving investment companies and advisers, and interpreting laws and regulations.

5. Division of Corporation Finance. Accountants deal primarily with this division on SEC matters. This division is described in greater detail in Section 5.1(c).

6. Office of Administrative Law Judges. Conducts hearings and brings rules on allegations of securities law violations initiated by the Commission.

7. Office of the General Counsel. The General Counsel is the chief law officer of the Commission. This office coordinates the SEC's involvement in judicial proceedings and provides legal advice and assistance.

8. Office of the Chief Accountant. The Chief Accountant is the Commission's principal adviser on accounting and auditing matters. The Office of the Chief Accountant:

a. Develops policy with respect to accounting and auditing matters and financial statement requirements

b. Supervises implementation of policies on accounting and auditing matters

c. Reviews complex, new, or controversial accounting and auditing problems of registrants

d. Considers registrants' appeals of decisions by the Division of Corporation Finance on accounting matters

e. Serves as liaison with and oversees the private sector standards-setting process working closely with the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) as well as the American Institute of Certified Public Accountants (AICPA)

f. Considers accountants' independence

g. Prepares Financial Reporting Releases (FRRs) and (in conjunction with the Division of Corporation Finance), Staff Accounting Bulletins (SABs)/Staff Legal Bulletins (SLBs)

h. Assists counsel in administrative proceedings relating to accounting and auditing matters

9. Office of Compliance Inspections and Examinations. Conducts examination and inspection programs for self-regulatory organizations, broker-dealers, transfer agents, investment companies, and investment advisers.

10. Office of Investor Education and Advocacy. Created by the SEC specifically to serve individual investors. The office makes sure the concerns and problems encountered by individual investors are known throughout the SEC and considered when the Agency takes action. It also carries out the SEC's investor education program.

11. Division of Risk, Strategy and Financial Innovation. Created by the SEC in 2009 to identify risks and trends in the financial markets. The division performs strategic analysis and identifies new trends in financial markets and systemic risks.

The main offices of the Commission are located at 100 F Street NE, Washington, DC 20549. There are also 11 regional offices. The regional offices are the field representatives of the Commission. It is their responsibility to provide enforcement and inspection capabilities throughout the country.

(c) Division of Corporation Finance

Because accountants generally deal more with the Division of Corporation Finance than with the other SEC divisions, its duties and operations are considered here in greater detail.

(i) Responsibilities

The division's principal responsibility is to ensure that financial information included in SEC filings is in compliance with the rules and regulations of the SEC. Its duties include:

1. Reviewing and commenting on

a. Registration statements for initial public offerings (IPOs)

b. Annual and quarterly filings

c. Proxy materials

2. Consulting with registrants and their advisers on accounting and filing issues

3. Issuing interpretive guidance in the form of the Financial Reporting Manual, Compliance and Disclosure Interpretations, PowerPoint presentations, and other informal guidance

4. Monitoring the use of IFRS by foreign private issuers

5. Working in conjunction with other divisions to issue concept releases, new rules, SABs and SLBs

The SEC does not pass on the merits of any proposed security issue. Although the SEC sets accounting and disclosure requirements that, in some cases, may be over and above those required by generally accepted accounting principles (GAAP), it does not generally prescribe the use of specific auditing procedures other than those related to certain regulated industries. It is the responsibility of the independent registered public accounting firm to determine whether the financial statements included in the filing have been audited in accordance with auditing standards adopted by the Public Company Accounting Oversight Board (PCAOB).

(ii) Organization

The division is supervised by a director who is aided by 3 deputy directors, 8 associate directors, and 12 assistant directors.

The division also has a chief counsel who interprets the securities laws and a chief accountant who supervises compliance in accounting and auditing matters. The chief accountant does not set policy; in novel or complex accounting situations, he or she may confer with the Commission's chief accountant.

Each assistant director office is staffed primarily by attorneys and accountants. Each office is responsible for certain specific industries, so that each reviewer is familiar with a registrant's type of business and can treat accounting and reporting matters consistently. A registrant is assigned to an industry group and then to a particular office based on the company's primary Standard Industrial Classification (SIC) Code.

Once a company's initial filing is assigned to an assistant director office for review, all subsequent matters relating to that company are generally handled by that office. The company's assignment to its specific office is shown in the Electronic Data Gathering, Analysis, and Retrieval system (EDGAR) after the basic company information. The assistant director offices have access to the Office of Engineering for assistance in technical areas such as mining. The Office of the Chief Accountant has valuation expertise as well.

(iii) Review Procedures

Filings with the division are customarily reviewed by an accountant and an attorney or financial analyst. The accountant's review will be directed toward determining adequate disclosure and compliance with GAAP and the applicable rules of the SEC. This review will also determine the appropriateness of the accounting and disclosures based on information in the textual section of the filing. As required by the Sarbanes-Oxley Act, every registrant is reviewed in some manner at least once every three years.

Comments from the review may result in issuing the registrant a “comment letter.” The assistant director approves comments made by the attorney or financial analyst, and a senior assistant chief accountant clears comments made by the accountant. If there are troublesome accounting problems, the division's chief accountant may confer with the Office of the Chief Accountant. In unusual situations, the Office of the Chief Accountant may bring the matter to the Commission's attention.

To minimize SEC comments regarding potential problem areas in the filing, the registrant may request a prefiling conference with the Commission's staff. Such conferences may also be held after the filing to resolve matters in the comment letter. The SEC has developed protocol for contacting the Office of the Chief Accountant or the Division of Corporation Finance for accounting issues. This protocol can also be found on the SEC's Web site in the section “Information for Accountants.” After a registrant has provided the written information, it can also request a face-to-face meeting to resolve the issue if necessary.

The registrant also may refer matters to the Office of the Chief Accountant and, in rare instances, to the Commission. This can occur either before filing or after receipt of the letter of comments.

Because of the significant volume of filings it receives on an annual basis, the division has adopted a selective review program. Registration and transactional proxy statements are given priority over the 1934 Act reports because of the tight time schedules associated with such filings. The selective review criteria are directed at reviewing all key filings, and registrants should expect all registration statements for initial public offerings to be thoroughly reviewed. If a registration or proxy statement is selected for review, the registrant will be notified.

Normally the division attempts to review a registration statement and provide initial comments within 30 days after the filing date. Comments are generally provided in writing and may be sent via e-mail.

Periodic reports under the 1934 Act may be reviewed on a selective basis after the filing date. Depending on the number and severity of the deficiencies, the SEC Staff will either require the registrant to amend the periodic report or may require only that the changes be implemented in future filings.

The 1934 Act permits the SEC to suspend trading in any security “for a period not exceeding 10 days” if it is in the public interest and is necessary to protect investors. Based on a Supreme Court decision, the SEC does not have the authority to issue suspensions beyond the initial 10 days.

(iv) EDGAR—Electronic Data Gathering Analysis and Retrieval System

The SEC utilizes its EDGAR system as its primary means of accepting filings from registrants. With a very few exceptions, most forms filed with the SEC are required to be filed electronically, including responses to comment letters and other information. Responses to comment letters and other correspondence do not become immediately available publicly; rather they only become publicly available after the completion of the filing review. Anyone with access to the Internet can review public filings made via EDGAR. The SEC's Web site contains a section related to EDGAR and how to use the system.

(v) Extension of Time to File

If a filing is not expected to be made on a timely basis, the SEC rules require that companies submit a notification on Form 12b-25, indicating the reason for extension, no later than one business day after the due date of the report. In addition, the rules provide relief where reports are not timely filed if a timely filing would involve unreasonable effort or expense. Under this provision, a report will be considered to be filed on a timely basis if these three provisions are met:

1. The required notification on Form 12b-25 (a) discloses that the reasons causing the inability to file on time could not be eliminated without unreasonable effort or expense, and (b) undertakes that the document will be filed no later than the 15th day following the due date (by the fifth day with respect to Form 10-Q).

2. There is a statement, attached as an exhibit to Form 12b-25, from any person other than the registrant (e.g., the independent accountant) whose inability to furnish a required opinion, report, or certification was the reason the report could not be timely filed without unreasonable effort or expense.

3. The report is filed within the represented time period.

This procedure does not require a response by the SEC.

Periodic reports that are filed late with the SEC may (1) prevent the registrant from using short-form registration statements on Form S-3, (2) cause injunctive action to compel filing, (3) make Rule 144 unavailable for the sale of shares by company officers, directors, or insiders (thus requiring registration of those shares before they can be sold), or (4) result in suspension of trading in the registrant's securities. The exchange often acts quickly to suspend trading of a security if the company has not filed information on a timely basis.

(d) Relationship Between the Accounting Profession and the Securities and Exchange Commission

The SEC and the accounting profession have cooperated with each other in developing GAAP. Through its FRRs, SABs, and SLBs, the SEC has informed the accounting profession of its opinions on accounting and reporting. In addition, the chief accountant and certain members of his or her staff attend meetings of the FASB, including the Emerging Issues Task Force (EITF), and technical committees of the AICPA.

In turn, as stated in FRR 1 (Section 101):

[T]he Commission intends to continue its policy of looking to the private sector for leadership in establishing and improving accounting principles and standards through the FASB with the expectation that the body's conclusions will promote the interests of investors. For the purpose of this policy, principles, standards, and practices promulgated by the FASB in its Statements and Interpretations will be considered by the Commission as having substantial authoritative support, and those contrary to such FASB promulgations will be considered to have no such support.

Although there has been an attempt to eliminate the differences between GAAP requirements and SEC accounting and reporting requirements, there are still certain key differences. Some of the additional requirements for SEC registrants are listed next.

Assets subject to lien (S-X Rule 4-08(b)). The rule requires the disclosure of the nature and approximate amount of assets mortgaged, pledged, or subject to liens.
Financial information of unconsolidated subsidiaries and 50-percent-or-less-owned equity method investees (S-X Rule 4-08(g) and 3-09). Depending on the significance of the investment, the SEC may require separate audited financial statements of the investee.
Income tax expense (S-X Rule 4-08(h)). Additional disclosure regarding the components of income tax expense (domestic foreign, other, etc.) and a numerical reconciliation between the reported income tax expense and the pretax income multiplied by the statutory rate is generally required.
Related party transactions (S-X Rule 4-08(k)). Related party balances are disclosed on the face of the financial statements.
Disclosure of the composition of “other” current assets, current liabilities, assets, and liabilities if the total exceeds certain thresholds (S-X Rule 5-02.8, 5-02.17, 5-02.20, 5-20.24).
Guarantor financial statements (S-X Rule 3-10). Depending on the significance and other criteria regarding the guarantors, the SEC may require separate financial information regarding guarantor and nonguarantor entities included in the consolidated financial statements.

For more detailed information related to these and other differences, see Section 5.4.

(e) Sarbanes-Oxley Act of 2002

In response to several significant restatements by public companies in late 2001 and early 2002, both the House of Representatives and the U.S. Senate proposed bills that could affect almost everyone associated with public companies. The two bills were quickly reconciled into the Sarbanes-Oxley Bill, which the President signed in late July 2002 and thus became the Sarbanes-Oxley Act (the Act).

The Act is very broad in scope and, numerous questions of interpretation have arisen and will continue to arise. A broad overview of certain provisions of the Act is presented next.

(i) Implications for Public Company Officers and Directors

Certifications.

Chief executive officer (CEO) and chief financial officer (CFO) certifications regarding annual and quarterly reports are required in accordance with two separate provisions of the Act. In certifications provided in response to Section 302 of the Act, the officers must each state:

They have reviewed the report.
Based on their knowledge:
- The report contains no untrue material fact and does not omit a material fact that would make the statements misleading, and
- The financial statements and other financial information in the report present fairly, in all material respects, the operations and financial condition of the company.
They are responsible for establishing and maintaining internal controls.
They have designed internal controls to ensure that material information relating to the issuer and its consolidated subsidiaries is made known to such officers by others within the company and its consolidated subsidiaries during the period in which the periodic reports are being prepared.
They have evaluated the effectiveness of internal controls as of the end of the period covered by the report and have presented their conclusions about such effectiveness based on their evaluation.
They have disclosed to the issuer's auditors and the audit committee all significant deficiencies and/or material weaknesses in the controls and any fraud involving management or other employees who have a significant role in the issuer's internal controls.
They have indicated in the report whether there were any significant changes in internal controls or other factors that might significantly affect internal controls subsequent to the date of their evaluation, including any corrective actions taken in response to deficiencies and/or material weaknesses.

Pursuant to Section 906 of the Act, such officers must also provide a certification for each periodic report containing financial statements filed with the SEC that:

The periodic report complies fully with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934.
The information provided presents fairly, in all material respects, the financial condition and results of operations of the company.

Maximum penalties for knowing violations of this section of the Act are fines of up to $1 million and/or imprisonment for up to 10 years; willful violations carry fines of up to $5 million and/or imprisonment of up to 20 years.

Internal Control Reports.

Companies must also file a report on internal control with their annual reports. This report must acknowledge management's responsibility for establishing and maintaining an adequate internal control structure and procedures for financial reporting and include an assessment as to the effectiveness of such structure as of its fiscal year-end.

Loans to Officers and Directors.

The Act, subject to certain limited exceptions, makes it unlawful for a company to extend credit to its directors and executive officers. However, existing loans were grandfathered, provided they are not materially modified or renewed.

Penalties for Violations of Securities Laws.

Under the Act, corporate officers are subject to new penalties. If a company restates its financial statements due to material noncompliance with financial reporting requirements, as a result of misconduct, any bonuses and other incentive-based or equity-based compensation received by the CEO and CFO during the 12 months following the filing of the noncompliant document, as well as any profits realized from the sale of securities during that period, must be returned to the company.

There are other provisions in the Act addressing corporate code of ethics, insider trading, and other issues.

(ii) Implications for Audit Committees

General Audit Committee Requirement and Responsibilities.

All public companies must have an audit committee. If one is not appointed, the entire board will be deemed to be functioning as the audit committee. The committee will be responsible for:

Appointment, compensation, and oversight of auditors, including resolution of any disagreements between management and the auditors
Establishing procedures for receiving and addressing complaints, including anonymous submissions, concerning accounting, internal control, or auditing matters
Engaging independent counsel or other advisers, as necessary, with funding to be provided by the company

Each audit committee member must be independent. Under the independence definition in the Act, the member may not receive fees from the company for any consulting, advisory, or other services (other than for services on the board) and may not be affiliated with either the company or its subsidiaries in any capacity other than as a director.

Financial Expertise Requirement and Disclosure.

Companies must disclose whether at least one member of the audit committee qualifies as a “financial expert.” When making such a determination, a company should consider an individual's:

Educational and professional background
Knowledge of GAAP and financial statements
Experience in preparing or auditing financial statements for comparable companies
Experience with internal accounting controls
Understanding of audit committee functions

(iii) Implications for Independent Auditors

Public Company Accounting Oversight Board.

The Act required the creation of the PCAOB. The PCAOB is comprised of five financially literate members (two current or former certified public accountants [CPAs] and three non-CPAs). Members, appointed by the SEC after consultation with the chairman of the Federal Reserve Board and the Secretary of the Treasury, may not be connected with any public accounting firm other than as retired members receiving fixed continuing payments and in general may not be employed or engaged in any other professional or business activity. The PCAOB is funded through fees collected from public companies, which are assessed based on its level of market capitalization.

The PCAOB's duties include adopting standards (e.g., auditing, quality control, ethics, and independence) related to the preparation of audit reports for public companies, conduct inspections of registered accounting firms, and conduct investigations and disciplinary proceedings, as necessary. When conducting investigations, the PCAOB is able to request and compel testimony, through subpoena requests, of public accounting firms and issuers. The PCAOB has the authority, subject to SEC review, to impose sanctions on accounting firms that are not in compliance with the Act.

Public Accounting Firms.

All accounting firms that audit public companies are required to register with the PCAOB. This requirement also extends to foreign accounting firms that audit a public company (a foreign private issuer as well as a U.S. company). Registered firms serving more than 100 public companies are subject to annual quality reviews conducted by the PCAOB. All other firms will be reviewed, at a minimum, on a triennial basis.

Auditor Independence Standards.

The Act imposed new restrictions on the types of services a public accounting firm could perform for a public company when it is serving as that company's auditor. Prohibited services include:

Bookkeeping services
Financial information systems design and implementation
Appraisal or valuation services, fairness opinions, or contribution-in-kind reports
Actuarial services
Internal audit outsourcing services
Management functions or human resources
Broker or dealer, investment adviser, or investment banking services
Legal services and expert services unrelated to the audit

Other nonaudit services, including tax services, may be provided but only if approved in advance by the company's audit committee. Approval of all nonaudit services must be disclosed in periodic reports.

The Act provides for mandatory rotation of the audit partner and engagement quality review partner such that neither can act in that capacity for more than five years. Accounting firms are also prohibited from auditing a public company if an individual from the accounting firm who participated in the company's audit during the one year preceding the initiation of the audit holds a financial oversight role at the company.

If a company meets the criteria of an accelerated filer (generally a public float of greater than $75 million), then its registered public accounting firm must also attest to and report on its internal controls over financial reporting as part of an integrated audit engagement. If a company has a material weakness in internal controls, the auditors must issue an adverse opinion on its internal control over financial reporting (ICFR).

Financial Disclosures.

The SEC added rules to require disclosure in quarterly and annual reports of material off-balance-sheet transactions, arrangements, obligations, and other relationships with related parties that may have a material current or future effect on financial condition and results of operations.

Additionally, the SEC issued rules covering non-GAAP financial information included in any periodic report, annual report, or press release. Key disclosures include:

A numerical reconciliation to the most comparable GAAP metric
Disclosure about the uses of the non-GAAP metric
Discussion of changes in the non-GAAP metric

Such non-GAAP metrics are generally prohibited from inclusion in the financial statements

(f) Qualifications and Independence of Public Accountants Practicing Before the SEC

To qualify for practice before the SEC, the public accountant auditing the financial statements must be independent, in good standing in the profession, and entitled to practice under the laws of his or her place of residence or principal office (Rule 2-01 of Regulation S-X). The firm must be registered with the PCAOB.

Both the SEC and the PCAOB have independence rules that cover public accountants who audit or play a substantial role in the audit of a public company. The rules focus on relationships or other services that would be deemed to impair the independence of the registered public accounting firm. The rules prohibit certain nonaudit services and require permitted nonaudit services (including tax services) to be preapproved by the company's audit committee. The rules also require annual disclosure of the amount and types of fees paid to the public accounting firm and the audit committee's preapproval policies of those fees.

(g) SEC's Focus on Accounting Fraud

The SEC's mission is to protect investors. Accounting fraud is one of the areas of significant concern. SEC officials have noted two types of accounting fraud: cooked books and cute accounting. Cooking the books involves falsifying books and records either by creating or accelerating revenues or by deferring or concealing expenses. Cute accounting involves misapplying or stretching accounting principles and interpretations to obtain the desired, albeit distorted, financial picture. Both the accounting profession and corporate officials have been reminded by the SEC of their responsibilities to the public investor. More specifically:

The SEC will carefully review Form 8-K reports to monitor changes in accountants. CPA firms should use caution when taking on new clients. A firm should review the work of the predecessor accountants to determine whether the change in accountants was the result of a company's refusing to comply with GAAP or violating federal securities laws. The SEC will take action against companies that shop for the most favorable accounting interpretations. The enforcement division will pursue not only these companies but also accounting firms that attempt to gain clients by disregarding GAAP.
Accountants should treat with healthy skepticism any changes in accounting policies or individual transactions that increase revenues or reduce expenses.
Accountants should avoid the tendency to rationalize otherwise questionable accounting positions. Firms should not take the view that “if it is not proscribed, it's permitted” but instead should use accounting procedures that follow both the letter and the spirit of SEC and FASB pronouncements.
Companies have a duty to disclose adverse nonpublic information (e.g., loss of a major customer) in the management's discussion and analysis section of Form 10-K. Furthermore, independent accountants are obligated not to sign off on filings if significant information is missing.

The SEC is concerned with opinion shopping and requires companies and their former auditors to make certain disclosures upon a change in outside auditor. FRR 31 provides additional guidance as to these disclosures.

FRR 31 explains that

the term disagreements should be interpreted broadly, to include any difference of opinion on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which if not resolved to the former accountant's satisfaction would have caused it to refer to the subject matter of the disagreement in connection with its report.

It further explains that preliminary differences of opinion that are “based on incomplete facts” are not disagreements if the differences are resolved by obtaining more complete factual information.

When an independent accountant who was the principal accountant for the company or who audited a significant subsidiary and was expressly relied on by the principal accountant resigns declines to stand for reelection or is dismissed, the registrant must also disclose:

Whether the former accountant resigned, declined to stand for reelection, or was dismissed, and the date of this action
Whether there was an adverse opinion, disclaimer of opinion, or qualification or modification of opinion as to uncertainty, audit scope, or accounting principles issued by such accountant for either of the two most recent years, including a description of the nature of the opinion
Whether the decision to change accountants was recommended by or approved by the audit committee or a similar committee, or by the board of directors in the absence of such special committee

Finally, the rules also require disclosure of certain “reportable events” during the two most recent fiscal years or any subsequent interim period preceding the resignation or dismissal of the accountant. “Reportable events” include the auditors having advised the registrant:

That the internal controls necessary to develop reliable financial statements do not exist
That information has come to the auditor's attention that led him or her to no longer be able to rely on management's representations, or that has made him or her unwilling to be associated with the financial statements
Of his or her need to significantly expand the audit scope or of information having come to the auditor's attention during the last two fiscal years and any subsequent interim period that, if further investigated, may (a) materially impact the fairness or reliability of either a previously issued audit report or the underlying financial statements or the financial statements issued or to be issued for a subsequent period or (b) cause him or her to be unwilling to rely on management's representations or to be associated with the financial statements and because of the change in auditors, the auditor did not expand his or her scope or conduct a further investigation
That information has come to the auditor's attention that what he or she has concluded materially impacts the fairness or reliability of either (a) a previously issued audit report or the underlying financial statements or (b) the financial statements relating to a subsequent period, and unless the matters are resolved to the auditor's satisfaction, the auditor would be prevented from rendering an unqualified report and, because of the change in auditors, the matter has not been resolved

Disagreements and reportable events are intended to include both oral and written communications to the registrant. Because these communications deal with sensitive areas that may impugn the integrity of management, they will have to be handled with extreme care on the part of all involved.

The time frame for reporting these changes is listed next.

The Form 8-K reporting the change should be filed by the end of the fourth business day following the day the former auditor is dismissed or notifies its client of its resignation or decision not to stand for reelection.
The letter from the former auditor should be filed by the registrant within two business days after it is received by the registrant.
The registrant should request the former auditor to furnish its letter “as promptly as possible.” To facilitate prompt responses, the rule requires the registrant to provide the former auditor with a copy of its report no later than the day the initial Form 8-K is filed with the SEC.
The auditor who is aware that a required filing related to a change of accountants has not been made by the registrant should consider advising the registrant in writing of that reporting responsibility with a copy to the Commission.

In addition, the PCAOB has a rule requiring auditors to communicate auditor changes directly to the SEC. Under that rule, when a firm has resigned, declined to stand for reelection, or been dismissed, it should notify the former client within five business days that the auditor-client relationship has ceased and should simultaneously send a copy to the SEC.

(h) Foreign Corrupt Practices Act

The Foreign Corrupt Practices Act of 1977 (FCPA) deals with (1) payments to foreign officials and (2) internal accounting control.

(i) Payments to Foreign Officials

The FCPA makes it illegal to offer anything of value to any foreign official, foreign political party, and so on (other than employees of foreign governments, etc., whose duties are ministerial or clerical), for the purpose of exerting influence in obtaining or retaining business. The prohibition against payments to foreign officials, as stated in this law, applies to all U.S. domestic concerns regardless of whether they are publicly or privately held. The FCPA may also apply to foreign subsidiaries of U.S. companies.

(ii) Internal Accounting Control

The FCPA makes it illegal for companies subject to SEC jurisdiction to fail to:

Keep books and records, in reasonable detail, that accurately and fairly reflect the transactions and disposition of the company's assets
Devise and maintain a system of internal accounting controls that will provide reasonable assurance that:
- Transactions are properly recorded in accordance with management's authorization.
- Financial statements are prepared in conformity with GAAP and accountability for assets is maintained.
- Access to company assets is permitted only with management's authorization.
- The recorded assets are checked and differences reconciled at reasonable intervals.

Shortly after the FCPA became effective, the SEC issued Accounting Series Releases (ASRs) No. 242, which states:

It is important that issuers subject to the new requirements review their accounting procedures, systems of internal accounting controls and business practices in order that they may take any actions necessary to comply with requirements contained in the Act.

To aid management in evaluating internal accounting control (which could be beneficial in judging whether a company complies with the accounting requirements of the FCPA), the AICPA formed a Special Advisory Committee on Internal Accounting Control. This committee issued a report that defines internal accounting control, develops related objectives (categorized by the committee as authorization, accounting, and asset safeguarding), and discusses what management should be doing with respect to an evaluation of these controls.

According to the committee's report, the internal accounting control environment should be a significant factor in management's assessment of the company's system. Along those lines, the report of the Special Advisory Committee on Internal Control (1979) states: “It is unlikely that management can have reasonable assurance that the broad objectives of internal accounting control are being met unless the company has an environment that establishes an appropriate level of control consciousness.”

The role of top management and the board of directors in establishing an appropriate internal accounting control environment is significant. The report considers the factors that shape such an environment to include “creating an appropriate organizational structure, using sound management practices, establishing accountability for performance, and requiring adherence to appropriate standards for ethical behavior, including compliance with applicable laws and regulations.”

A strong control environment may include, for example, clearly defined accounting policies and procedures, clearly established levels of responsibility and authority, periodic evaluations of employees to determine that their performance is consistent with their responsibilities, budgetary controls, and an effective internal audit function. A strong control environment will provide more assurance that the company's internal accounting control procedures are followed. A poor internal accounting control environment, however, could negate the effect of specific controls (e.g., employees may hesitate to challenge management override of control procedures).

After assessing the control environment, management should evaluate the internal accounting control system. There are several approaches to such an evaluation, depending, for example, on the organizational structure of the company and its type of business. The report uses a “cycle” approach in illustrating an evaluation of internal accounting control, although other approaches may be acceptable (e.g., by function or operating unit). Under the cycle approach, transactions are grouped into convenient cycles (e.g., revenues, expenditures, production or conversion, financing, and external financial reporting), and appropriate internal accounting control criteria are identified for each cycle. In addition, the existing control procedures and techniques used by the company to meet the related criteria should be evaluated.

Meeting internal accounting control criteria generally reduces the risk of material undetected errors and irregularities. Of course, there are inherent limitations to any system of internal accounting control. Even though internal accounting control procedures are performed and the related criteria are met, collusion or override can circumvent existing procedures. Even a strong system of internal accounting control can provide only reasonable assurance for the timely detection of errors or irregularities. However, nonachievement of criteria increases the likelihood that (1) transactions not authorized by management will occur, (2) transactions will not be properly recorded, and (3) assets will be subject to unauthorized access.

The FCPA's legislative history recognizes that the aggregate cost of specific internal controls should not exceed the expected benefits to be derived. Therefore, the report concludes that if it is determined that an internal accounting control criterion is not met, management should evaluate the “cost/benefit” considerations of modifying existing procedures or adding new ones. In determining the aggregate cost, consideration should be given to the direct and indirect dollar cost (e.g., additional personnel, new forms) and whether the new or modified procedure slows the decision-making process or has other deleterious effects on the company. To measure the expected benefit, management should evaluate the likelihood that an error or irregularity could result in a loss to the company or in a misstatement in its financial statements, and evaluate the extent of such loss or misstatement.

Because the system of internal accounting control depends on employees' performing their assigned duties, the report indicates that management should establish a program to obtain reasonable assurance that the controls continue to function properly. The nature of the monitoring program will vary from company to company and will depend on the company's size and organizational structure, the degree of managerial involvement in its day-to-day operations, and the complexity of its accounting system. Ordinarily, monitoring occurs through supervision, representations, audits, or other compliance tests, and so on.

(i) Audit Committees

The SEC, the New York Stock Exchange (NYSE) and the Nasdaq all have certain independence requirements for audit committee members of registrants or companies that list on the respective exchange. The SEC's rules require that audit committee members be members of the board of directors and generally not accept compensation from the registrant except for services as a board member and that they may not otherwise be an affiliated person of the registrant or a subsidiary. Directors who are members of current management or who serve the company in an advisory capacity, such as consultants or legal counsel, and relatives of executives are not considered independent directors. Former company executives who serve as directors can serve on the audit committee if, in the opinion of the board, that person will exercise independent judgment and will materially aid and assist the function of the committee. The SEC also requires registrants to disclose if the audit committee has a financial expert and if not, why it does not.

The NYSE and Nasdaq both require listed companies to have audit committees composed of at least three members meeting the independence criteria just noted. In addition, NYSE audit committee members must be financially literate (as defined in the NYSE rules), and Nasdaq audit committee members must be able to read and understand financial statements.

(j) Contact with SEC Staff

Contact with the SEC Staff can be both formal and informal and can occur in various situations including:

Registration. The SEC review of 1933 Act registration statements is described later. The company issuing the securities and its lawyers, underwriters, and accountants work closely with SEC Staff to produce a document that the SEC will not contend lacks full disclosure.
Filing Reviews. A filing review is an SEC Staff review of a 1934 Act filing including annual reports, current reports and proxy statements and issuance of a comment letter.
Investigation. The SEC Staff, typically from the enforcement division, can make an informal investigation when it believes securities laws have been violated. Such investigations may be prompted by market activity in a stock that is not justified by publicly available information or by news accounts of possible wrongdoing, complaints from the investing public, references from stock exchanges and the National Association of Securities Dealers, or references from other law enforcement agencies. People do not have to assist the SEC Staff in its investigation and instead can force the Staff to proceed immediately to a formal investigation, authorized by the Commission when justified. The formal order of investigation will name the SEC Staff members who are authorized to issue subpoenas for the production of witnesses and documents.
Interpretation. As a general rule, the U.S. legal system does not allow people to obtain interpretations of the law before an act is committed. Only through litigation can a person know whether a violation has occurred. However, administrative agencies often provide some exceptions to the rule.

A formal interpretation from the SEC is obtained by receiving a no-action letter. This communication is a SEC Staff promise not to recommend to the Commission that it take action if the facts submitted by the applicant and described in the letter are found to be accurate. The Commission has always honored its Staff's no-action letters. Typical no-action letters involve exemption from 1933 Act registration and refusals by corporations to include a stockholder proposal in the company's proxy material.

The SEC will respond to informal questions related to interpretations of rules and the like. In certain circumstances, the Staff will respond to questions without requiring disclosures of the name of the registrant. Generally, these “no-name” inquiries are on more general questions. In fact-specific questions, the Staff will often request a written submission regarding the facts and circumstances and will request that the name of the registrant be disclosed in the submission. The Staff has a specific protocol it suggests that registrants use if they wish to submit an issue to the SEC Staff members to obtain their views. These issues typically cover interpretations of which financial statements need to be filed by a registrant and for what periods as well as unique or unclear accounting interpretations.

(k) Current Reference Sources

To keep abreast of SEC developments, accountants and others mainly consult these publications:

The Federal Securities Law Reporter, published by Commerce Clearing House (New York), is a loose-leaf service containing all federal securities laws, SEC rules, forms, interpretations and decisions, and court decisions on securities matters.
The SEC News Digest is a daily summary of important SEC developments it is available on the SEC's Web site.
The SEC's Web site, www.sec.gov, provides the full extent of all SEC releases and of speeches made by members of the Commission and its Staff.

5.2 Securities Act of 1933

(a) Transactions Covered

The preamble to the 1933 Act states that the Act is intended “to provide full and fair disclosure of the character of securities sold in interstate and foreign commerce and through the mails, and to prevent frauds in the sale thereof, and for other purposes.”

The 1933 Act does not cover the most common sale of securities: sales of issued and outstanding securities. Those transactions, on a stock exchange, in the over-the-counter (OTC) market or otherwise, are regulated by the 1934 Act. The 1933 Act covers only the original sale of the security by the issuer, along with sales by persons in control of an issuer.

There are two primary aspects to the 1933 Act regulation of securities offerings:

1. The sale must be registered with the SEC, and purchasers must be furnished with much of the information contained in the registration statement in the form of a prospectus (1933 Act, Sections 5, 6).

2. Purchasers of the securities who suffer losses within a specified time period may recover their losses if the registration statement contained a materially misleading statement (1933 Act, Section 11). Recovery can be obtained from the issuer. However, the proceeds from the sale may have been squandered; therefore, recovery is permitted from directors, underwriters, and any expert, such as an accountant, if the material misrepresentation was in the audited financial statements. All defendants, other than the issuer, may avoid liability by proving their due diligence in reviewing the registration statement.

(b) Auditors' Responsibilities

As to the audited financial statements, auditors must prove that they had,

after reasonable investigation, reasonable ground to believe, and did believe, at the time…the registration statement became effective, that the statements [in the audited financial statements] were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading. [1933 Act, § 11(b)(3)]

Section 11(c) of the Act states: “The standard of reasonableness shall be that required of a prudent man in the management of his own property.”

The BarChris case—Escott v. BarChris Construction Corp., 283 F. Supp. 643, U.S. District Court, Southern District of New York, 1968—was the first, and remains the most important, case regarding liability for a misleading 1933 Act registration statement. A major accounting firm was among the defendants found not to have fulfilled due diligence requirements. The court stated: “Accountants should not be held to a standard higher than that recognized in their profession.” However, the court relied heavily on the failure of the firm to follow its own guidelines for reviewing events since the date of the statements for the purpose of ascertaining whether the audited financial statements were misleading at the time the registration statement became effective. The complete text of the BarChris case appears in Regulating Transactions in Securities.¹

(c) Materiality

When the Securities Acts require plaintiffs to prove that information was false, untrue, or misleading, the plaintiffs must also show that the information was material to investors. In general, neither the statutes nor the SEC's rules and regulations offer quantitative tests or useful verbal descriptions of the meaning of materiality. For example, as to the information required to be filed in a 1933 Act registration statement, information is material if “an average prudent investor ought reasonably to be informed [of it]” (1933 Act, Rule 405).

Many cases involve attempts to further define materiality. In the BarChris case, the judge used the test of “a fact which if it had been correctly stated or disclosed would have deterred or tended to deter the average prudent investor from purchasing the securities in question.” Starting in the mid-1970s, some courts admitted that they would have to apply materiality standards in a flexible manner, reflecting the context in which the misleading statement was made (e.g., a 1933 Act registration statement, a 1934 Act registration statement or periodic report, a proxy statement, a case involving insider trading or tipping, etc.).

In SAB No. 99, Materiality (August 12, 1999), the SEC Staff states that accountants and independent auditors should not rely exclusively on quantitative benchmarks to determine materiality in preparing or auditing financial statements. Misstatements are not immaterial simply because they fall beneath a numerical threshold.

(i) Assessing Materiality

A company or its independent auditor becomes aware that combined misstatements or omissions overstate net income 4 percent and earnings per share $0.02 (4 percent). No item in the consolidated financial statements is misstated by more than 5 percent, nor are there any particularly egregious circumstances, such as self-dealing or misappropriation. Management and the independent auditor conclude that the accounting is permissible.

The Staff concludes that the materiality of items may not be determined based simply on whether they fall beneath any percentage threshold set by management or the independent auditor. The Staff does not object to the use of a percentage threshold as an initial step in determining materiality. But that is only the beginning. A full analysis of relevant conditions is required. Materiality concerns the significance of an item to users of financial statements. A matter is material if it is substantially likely that a reasonable person would consider it important. The context of the surrounding circumstances or the total mix of information requires assessment. Both quantitative and qualitative factors are involved. The FASB, the AICPA auditing literature, and the U.S. Supreme Court have emphasized these matters concerning materiality.

The SEC Staff thus believes that there are numerous circumstances in which misstatements below 5 percent could be material and that qualitative factors could cause quantitatively small misstatements to be material. Examples of such factors are presented next.

Whether the misstatement is based on a precise measurement or on an estimate and the degree of imprecision inherent in the estimate. A misstatement of a given amount in the former case is more likely to be material than in the latter case.
Whether the misstatement masks a change in earnings trends or other trends.
Whether the misstatement hides a failure to meet analysts' consensus expectations for the company.
Whether the misstatement changes a loss into income or vice versa.
Whether the misstatement affects the company's compliance with regulatory requirements.
Whether the misstatement affects the company's compliance with contractual requirements.
Whether the misstatement increases management's compensation, for example, by satisfying requirements for the award of incentive compensation.

The potential market reaction to a misstatement is too blunt an instrument to be used by itself in determining its materiality. However, the demonstrated volatility of the price of a company's securities in response to certain kinds of disclosures may provide guidance as to whether investors consider quantitatively small misstatements material. Expectations based, for example, on a past pattern of market performance that a known misstatement may cause a significant positive or negative market reaction should be considered in determining the materiality of the item.

The intent of management may provide significant evidence of materiality, particularly if management has intentionally misstated items to manage reported earnings, presumably believing that the amounts and trends that result would be significant to users of the financial statements. The SEC Staff believes that investors generally would consider significant a management practice to overstate or understate earnings just short of a percentage threshold to manage earnings and an accounting practice that, in essence, made all earnings amounts subject to a management-directed margin of misstatement.

The location of an item may affect its materiality. For example, a misstatement of the revenue and operating profit of a relatively small segment represented by management to be important to future profitability is more likely to be material to investors than a misstatement of the same percentage of a routine segment.

(ii) Aggregating and Netting Misstatements

In determining the effects on the financial statements taken as a whole, each misstatement should be considered separately, and the aggregate effect should also be considered. The effects on individual line item amounts, subtotals, and totals should be considered. Misstatements of material amounts, such as of revenue, are not cured by misstatements of other amounts, such as of expenses. In considering the effect of misstatements on subtotals or totals, care should be taken in offsetting a misstatement of an amount based on an estimate and an amount capable of precise measurement.

SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, clarifies that management and auditors also need to consider the impact of potential misstatements on both a rollover and an iron curtain basis. In other words, consideration needs to be given to the impact of correcting the cumulative error in the balance sheet as well as the current-year income statement impact. If the misstatement to the current-year income statement due to correcting the cumulative error in the balance sheet is material, then prior-year financial statements may need to be amended.

(iii) Intentional Immaterial Misstatements

Management may try to manage earnings by intentionally adjusting various financial statement items in a manner not in conformity with GAAP. The adjustments are not material separately or in the aggregate.

The SEC Staff concludes that in certain circumstances, intentional immaterial misstatements are unlawful. The Staff believes that the FASB's statement in each of its Statements of Standards that it need not be applied to immaterial items does not cover intentional misstatements. Sections 13(b)(2)–(7) of the Exchange Act require registrants to make and keep books, records, and accounts that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the registrant and must maintain internal accounting controls sufficient to provide reasonable assurances that, among other things, transactions are recorded as necessary to permit the preparation of financial statements in conformity with GAAP. In this context, the terms reasonable assurance and reasonable detail are not based on materiality but on the level of detail and degree of assurance that would satisfy prudent officials in the conduct of their own affairs. Reasonableness in this context is not solely based on the significance of the item to investors. It reflects instead a judgment as to whether an issuer's failure to correct a known misstatement implicates the purposes underlying the accounting provisions of Sections 13(b)(2)–(7) of the Exchange Act. Also, U.S. Code Sections 78 m(4) and (5) provide that criminal liability may be imposed if a person knowingly fails to implement a system of internal accounting controls or knowingly falsifies books, records, or accounts. These factors should be considered in assessing whether a misstatement results in a violation of a registrant's duty to keep books and records that are accurate in reasonable detail:

It is reasonable to treat misstatements that are clearly inconsequential differently from more significant ones.
It is likely never reasonable to record or not to correct known misstatements in an ongoing senior management effort to manage earnings.
Small misstatements need not be corrected if it would involve major expenditures. But not correcting any misstatement at little cost is not reasonable.
Not correcting an item that agrees with one of two or more reasonable interpretations of authoritative accounting guidance may be reasonable. However, if there is little ground for reasonable disagreement, the case for not correcting a misstatement is correspondingly weaker.

An independent auditor who discovers an illegal act as defined by Section 10A(b) of the Exchange Act, regardless of whether it is perceived to materially affect the financial statements being audited irrespective of netting, must, unless it is clearly inconsequential, among other things, inform the appropriate level of management and be sure that the audit committee is adequately informed. The independent auditor may also have to reevaluate the degree of audit risk in the engagement; determine whether to revise the nature, timing, and extent of audit procedures; and consider whether to resign. The intentional misstatement may also suggest to the independent auditor the existence of reportable conditions or material weaknesses in internal accounting control designed to detect and deter improper financial reporting or a lax tone set by top management. The independent auditor must report such conditions to the audit committee.

If the independent auditor determines that the company or the board of directors has failed to take remedial action, then the auditor may need to report directly to the SEC.

(d) Smaller Reporting Companies

During 2007, the SEC acted on the 2006 recommendations of its Advisory Committee on Smaller Public Companies by finalizing rules that extended reporting relief to a category of registrants defined as “smaller reporting companies.” Smaller reporting companies are defined as companies with less than $75 million of public float. These rules eliminated the former category of filers defined as “small business issuers” and the related small business forms, and moved the financial and nonfinancial reporting requirements for smaller reporting companies from Regulation S-B into Regulation S-X and Regulation S-K, respectively

Existing registrants measure their market capitalization as of the end of their most recent fiscal second quarter. For a company filing an IPO or an initial registration statement, the public float is calculated as of a date within 30 days of the filing date and is determined based on the number of shares held by nonaffiliates before the offering and the estimated IPO price. Registrants with no public float (e.g., only publicly issued debt) can be considered as smaller reporting companies if its annual revenue is less than $50 million.

Exhibit 5.1 Differences Between General Regulation S-X and Article 8 of Regulation S-X Requirements

Topic	Difference
Annual periods to be presented	Article 8 requires only two years of financial statements
Financial statements of acquired businesses	Under Article 8, no more than two years of financial statements are required
Financial statement disclosures	Most of the disclosures required by Reg. S-X that exceed the requirements of GAAP are not required.
Separate financial statement of significant equity investees	Not required
Financial statements schedules	Not required

Exhibit 5.2 Principal Differences Between General Regulation S-K Requirements and Those for Smaller Reporting Companies

Topic	Difference
Description of business	Registration statements need to discuss the business historical development for only three years, instead of five
Selected financial data	Not required
Selected quarterly financial information	Not required
Risk factors	Not required
Performance graph	Not required
Table of contractual obligations	Not required
Market risk disclosures	Not required
Executive compensation	Specific disclosures and the number or individuals covered by certain disclosures is less comprehensive than for regular filers

Registrants qualifying as a smaller reporting company may elect on an item-by-item basis whether to comply with the regular filer rules or the smaller reporting company rules. Exhibits 5.1 and 5.2 identify some important differences in the rules for smaller public companies.

(e) Exemptions from Registration

This section discusses the exemptions from the registration process and the simplified filings available to a company contemplating an offering under the 1933 Act.

The 1933 Act gives to the SEC the authority to establish rules for exempting securities from registration, if offered in small issues or if offered to a limited number of investors. Rules 501 through 509 of the 1933 Act, referred to as Regulation D, cover limited offerings and sales of securities, whereas Rules 251 through 263, called Regulation A, cover the small offering exemptions.

(i) Regulation D

Regulation D was adopted in 1982 to allow small businesses to raise capital without the burdens imposed by the registration process.

The regulation comprises Rules 501 to 508. Rules 501 to 503 contain definitions, terms, and conditions that generally apply throughout the regulation. Rules 504 to 506 provide the three exemptions from registration under Regulation D:

Rule 504 relates to offerings where the aggregate sales price does not exceed $1 million in a 12-month period. This exemption is not available to companies subject to the 1934 Act reporting requirements or to an investment company registered under the Investment Company Act of 1940 or certain development-stage companies.
Rule 505 relates to offerings up to $5 million in a 12-month period to an unlimited number of “accredited” investors (defined later) and to a limit of 35 other purchasers not meeting the accredited investor definition. This exemption is not available to registered investment companies.
Rule 506 permits offerings, without regard to the dollar amount, to no more than 35 purchasers meeting certain sophistication standards and an unlimited number of accredited investors. This exemption requires, among other things, that the issuer reasonably believe that the nonaccredited purchaser, or representative, has adequate knowledge and experience in finance and business to evaluate the merits and risks of the securities offered. This rule has no qualifications as to the issuer.
Rule 507 addresses the disqualifying provision relating to exceptions under Rules 504, 505, and 506.
Rule 508 relates to the insignificant deviations from a term, condition, or requirement of Regulation D.

Accredited Investor.

An accredited investor includes institutions or individuals who come within, or whom the issuer reasonably believes come within, any of these nine categories:

1. An institutional investor, such as a bank, insurance company, or an investment company registered under the Investment Company Act of 1940

2. A private business development company, as defined in the Investment Advisers Act of 1940

3. An employee benefit plan qualifying under the Employee Retirement Income Security Act (ERISA) with total assets over $5 million, if the plan's investment decisions are made by a bank, insurance company, or registered investment adviser

4. A tax-exempt organization under the Internal Revenue Code with total assets in excess of $5 million

5. Any director, executive officer, or general partner of the issuer

6. Any trust, with total assets in excess of $5 million, not formed for the specific purpose of acquiring the securities offered whose purchase is directed by a sophisticated person

7. A person whose individual net worth or joint net worth with spouse at the time of the purchase exceeds $1 million

8. A person whose individual income for each of the two most recent years is in excess of $200,000 or income jointly with that person's spouse in excess of $300,000 and reasonably expects income in excess of $200,000 (or jointly $300,000) in the current year

9. Any entity in which all the equity owners are accredited investors

Disclosure Requirements.

The disclosure requirements of Regulation D are based on the nature of the issuer and the size of the offering depending on these three items:

1. An issuer offering securities under Rule 504 and 504a or to only accredited investors is not required to furnish disclosures.

2. Companies not subject to the 1934 Act reporting requirement must furnish:

For offerings up to $2 million, the same kind of information as would be required in Part II of Form 1-A and Article 8 of Regulation S-X, except that the issuer's balance sheet, which must be dated within 120 days of the start of the offering, must be audited.
For offerings up to $7.5 million, the same information required for smaller reporting companies filing an S-1. Generally, financial statements for the two latest years are required. If audited financial statements cannot be obtained without reasonable effort and expense, then only the balance sheet need be audited, which must be dated within 120 days.
For offerings over $7.5 million, the same information specified in the form a registrant would qualify to use that would be required in a full registration statement. If audited financial statements cannot be obtained without reasonable effort and expense, then only the balance sheet need be audited, which must be dated within 120 days.

Limited partnerships may furnish income tax basis financial statements if their preparation in conformity with GAAP would be unduly burdensome or costly.

3. Companies subject to the 1934 Act reporting requirements are required to furnish:

Either: The latest annual stockholders' report, related proxy statement and, if requested, Form 10-K, or the information (but not the Form itself) contained in the most recent Form 10-K or registration statement on Form S-1 or Form 10.
Most recent interim filings.

Conditions to Be Met.

In addition to the qualifications to be met by issuers under Rules 504 and 505, Regulation D includes these limitations and conditions:

Except as provided in Rule 504, no form of general solicitation or general advertising can be used by the issuer or any person acting on its behalf to offer the securities. The issuer or the person acting on its behalf (e.g., an underwriter) must have a preexisting relationship with the offeree.
Except as provided in Rule 504, securities sold under Regulation D will be “restricted” securities with limited transferability. Each stock certificate issued should include a legend stating the security is restricted as to transferability.

(ii) Regulation A

Regulation A allows a company to publicly offer its securities without registration under the 1933 Act. Instead, an offering statement (Form 1-A) is filed and qualified with the SEC. Two principal attractions of Regulation A are that only two years of financial statements are necessary, and the financial statements may be unaudited if audited information is not already available. Further, the completion of a Regulation A offering does not automatically subject the issuer to 1934 Act reporting. The limit for securities offerings under Regulation A is $5 million in any 12-month period (of which $1.5 million can be sales by selling security holders). Issuers are allowed to test the waters before filing the offering statement with the SEC. Also, Form 1-A allows the optional use of a user-friendly question-and-answer form (the Small Company Offering Registration (SCOR) form) used by several states for the registration of Regulation D offerings. Under the rules for prefiling communications, issuers can solicit indications of interest through the distribution or publication of preliminary materials. In general, the content of these materials is unregulated, except that it is limited to factual information. However, the preliminary materials must include a brief general description of the company's business and products, the business experience of the chief executive officer, and a statement that no money is being solicited or accepted until the qualification and delivery of the offering circular. Any solicitation of interest material must be filed with the SEC on the date it is first used, and oral communications to gauge investor interest are permitted once the solicitation of interest document is filed. However, the rules also require that the use of the solicitation statement must be discontinued once the preliminary offering statement has been filed, and they call for a 20-day lapse between the last use of the solicitation statement and the first sale of any securities.

(iii) Other Exemptions

Other exemptions from the registration requirement are:

Offerings restricted to residents of the state in which the issuer is organized and does business, provided the issuer has at least 80 percent of its revenue and assets within the state and at least 80 percent of the net proceeds of the offering are used within the state (Rule 147)
Securities of some governmental agencies
Offerings of small business investment companies (Regulation E)

(f) “Going Private” Transactions

Companies may repurchase their shares from the public and, in turn, become privately held. When shares are held by fewer than 300 shareholders or fewer than 500 shareholders if there are minimal assets and the company no longer lists on a national exchange, a company can choose to cease filing and go private. If the registrant is engaging in a transaction to go private, SEC Rule 13e-3, which prohibits going private transactions that are fraudulent, deceptive, or manipulative may apply. Under the rule, companies are required to state whether the transaction is fair to stockholders unaffiliated with management and to provide a detailed discussion of the material factors on which that belief is based. Among the factors that should be addressed are: (1) the purpose of the transaction and what other alternatives were considered; and (2) whether the consideration offered to unaffiliated stockholders constitutes fair value in relation to current and historical market prices, net book value, going concern value, liquidation value, purchase price in previous purchases, and any report, opinion, or appraisal obtained on the fairness of the consideration.

Rule 13e-4, relating to an issuer's tender offer for its own securities, also imposes stringent disclosure requirements and other responsibilities on registrants. The rule requires that:

1. An issuer's tender offer remain open for at least 20 business days.

2. A shareholder tendering stock have the right to withdraw within the first 15 business days or after 40 business days following the announcement if the company has not acted on its offer.

3. Officers, directors, and major shareholders disclose all their stock transactions during the 40 business days preceding the purchase offer.

4. An issuer accept tendered securities on a pro rata basis if a greater number of securities is tendered than the issuer is obliged to accept within 20 days of an offer.

(g) Initial Filings

The information requirements for initial and other registration statements and annual filings are very similar and are based on an integrated disclosure system. The rules applicable to Form 10-K require much of the same financial statement information required in a registration statement. However, there are some unique aspects of initial filings. Initial filings are most commonly filed on Form S-1, but other forms may be used in specific circumstances. Form S-3, however, is available only to an existing registrant and is considered an abbreviated form.

The most commonly used forms for registration under the 1933 Act are listed next.

S-1	General form to be used when no other form is specifically prescribed. Disclosures are similar to those required for Form 10-K.
S-3	For companies that have been reporting to the SEC for 12 or more months and meet a “float” test ($75 million or more of voting and nonvoting stock held by nonaffiliates). Form S-3 allows maximum incorporation by reference and requires the least disclosure in the prospectus. Form S-3 may also be used for certain other types of transactions without meeting the float test.
S-4	For securities to be issued in certain business combinations and that are to be redistributed to the public.
S-6	For unit investment trusts registered under the Investment Company Act of 1940 on Form N-8B-2.
S-8	For securities to be offered to employees under certain stock option, stock purchase, or similar plans.
S-11	For registration of securities issued by certain real estate investment trusts and by companies whose primary business is acquiring and holding real estate.
F-1, F-3, and F-4	Registration of the securities of certain foreign private issuers including certain forms specifically for Canadian issuers.

The SEC requires issuers to write the cover page, summary, and risk factors section of prospectuses in plain English. The SEC also gives guidance to issuers of prospectuses on how to make the entire prospectus clear, concise, and understandable. Further, it issued A Plain English Handbook: How to Create Clear SEC Disclosure Documents, (available at www.sec.gov/pdf/handbook.pdf which provides techniques and tips on how to create plain-English disclosure documents.

The organization, language, and design of the covered sections of the prospectus should conform to plain-English principles and be easy to read. Qualities of writing involved in plain English include short sentences; definite, concrete, everyday language; the active voice; tabular presentation or bullet lists for complex information whenever possible; no legal jargon or highly technical business terms; and no multiple negatives. The sections should be designed to make them inviting to the readers. The text should be formatted and the document designed to highlight information important to investors.

The SEC requires registrants to use these techniques in writing prospectuses:

Sections, paragraphs, and sentences must be clear and concise.
Short explanatory sentences and bullet lists should be used whenever possible.
Terms used should ordinarily be made understandable in context. Terms should be defined in glossaries only if they cannot be made understandable in context and if defining the terms that way facilitates understanding of the disclosure.
Legal and highly technical business terminology should be avoided.

The SEC requires registrants to avoid these conventions:

Legalistic or overly complex presentations that cloud the substance of the disclosure
Vague boilerplate explanations readily subject to differing interpretations
Complex information taken from legal documents without clear and concise explanation
Repetition that adds to the length of the prospectus without adding to the quality of the information

The goal of the guidance on how to make the entire prospectus clear, concise, and understandable is to rid the entire prospectus of legalese and repetition so that information important to investors is not blurred.

The SEC Staff assists registrants in complying with the rule.

5.3 Securities Exchange Act of 1934

(a) Scope of the Act

The 1934 Act has six principal parts:

1. Creation and operation of the SEC

2. Regulation of stock exchanges and the OTC market

3. Regulation of brokers and dealers

4. Corporate disclosure requirements

5. Regulation of corporate managers, large stockholders, and preparers of filed statements

6. Prohibition against fraud in securities transactions

(b) Corporate Disclosure Requirements

(i) Registration of Securities

Unlike the registration of securities transactions under the 1933 Act, under the 1934 Act registration is a one-time event for an issue of securities.

Issuers of securities registered on a national securities exchange (listed securities), and companies that have assets exceeding $1 million and 500 or more shareholders of record, must register by filing Form 10. The information required in Form 10 is very similar to the information required in an annual report, which is discussed later. This form requires 16 items of information:

1. Business

1A. Risk Factors

2. Financial information

3. Properties

4. Security ownership of certain beneficial owners and management

5. Directors and executive officers

6. Executive compensation

7. Certain relationships any related transactions

8. Legal proceedings

9. Market price of and dividends on the registrants' common equity and related stockholder matters

10. Recent sales of unregistered securities

11. Description of registrants' securities to be registered

12. Indemnification of directors and officers

13. Financial statements and supplementary data

14. Changes in and disagreements with accountants on accounting and financial disclosure

15. Financial statements and exhibits

(ii) Periodic Reports

Registrants under the 1934 Act (as defined earlier), or any issuer that ever sold securities pursuant to an effective 1933 Act registration statement and has 300 or more shareholders of record, must file periodic reports with the Commission. Principally, these reports are Form 10-K (an annual report), Form 10-Q (a quarterly report), and Form 8-K (current report).

These reporting requirements may be eliminated for companies with equity securities registered under Section 12(b) or 12(g) of the 1934 Act if:

The number of holders of record of a class of security decreases at any time to less than 300 (and the company has filed at least one Form 10-K)
The company certifies that it had fewer than 500 holders of record and on the last day of each of the last three fiscal years the total assets have not exceeded $10 million (and the company has filed at least three Form 10-Ks since its most recent registered securities offering)

For companies with a class of security registered under the 1933 Act—that is, not Section 12(b) or 12(g) companies—these reporting requirements, as required solely by Section 15(d) of the 1934 Act, may be suspended if:

Ownership falls below 300 persons at the beginning of a fiscal year and a 1933 Act filing does not become effective during that year (a company whose securities were registered with the SEC on or before August 20, 1964, may discontinue filing if the value of the outstanding securities of the registered class falls below $1 million, even though there are at least 300 holders of record); or
The company certifies that it had fewer than 500 holders of record and, on the last day of each of its last three fiscal years, its total assets have not exceeded $10 million and a 1933 Act filing does not become effective during that year.

A company that desires an exemption from periodic reporting should file Form 15 with the SEC.

Exchange Act Rule 12b-15 covers the procedures for amending previous Exchange Act filings:

1. Registrants are required to make amendments under cover of the form being amended. The fact that the filing is an amendment will be designated by adding the letter “A” after the form title (e.g., Form 10-K/A).

2. Amendments are required to set forth the complete text of each item amended rather than only revised words or lines.

5.4 Form 10-K and Regulations S-X and S-K

Form 10-K is the annual report required to be filed by companies whose securities are registered with the SEC. The due date of the filing varies based on the classification of the registrant as a smaller reporting company, nonaccelerated filer, accelerated filer, and large accelerated filer. Annual reports of smaller reporting companies and nonaccelerated filers are due 90 days after the end of the registrant's fiscal year; accelerated filers' annual reports are due 75 days after the end of the registrant's fiscal year; and large accelerated filers' annual reports are due 60 days after their fiscal year-end.

The filings are reviewed by the Division of Corporation Finance. As indicated in Subsection 5.1(c)(iii), the SEC Staff may review Form 10-K on a selective basis after the filing date. However, the filings that are reviewed are subjected to close scrutiny.

The SEC issues a set of instructions concerning the preparation of Form 10-K. Form 10-K is prepared using Regulation S-X, which prescribes requirements for the form, content, and periods of financial statements and for the accountant's reports, and Regulation S-K, which prescribes the other disclosure requirements.

The Form 10-K text (as distinguished from financial statements and related notes) generally is prepared by the company with assistance, if necessary, from the attorneys.

The accountant should read the entire Form 10-K text for the omission of pertinent information in the financial statements and to avoid inconsistencies between the financial statements and the text. Also, the accountant may become aware of information in the text that he or she believes to be misleading (see Statement of Accounting Standards No. 8, Other Information in Documents Containing Audited Financial Statements).

Form 10-K and related documents must be submitted electronically via the EDGAR system.

(a) Regulation S-X

The form and content of and requirements for financial statements included in filings with the SEC are set forth in Regulation S-X. Regulation S-X rules, in general, are consistent with GAAP but contain certain additional disclosure items not provided for by GAAP, as discussed later.

Regulation S-X is organized into 13 articles:

Article 1—Application of Regulation S-X. Contains certain definitions that are used throughout Regulation S-X.
Article 2—Qualifications and Reports of Accountants. Contains the SEC rules on the qualification and independence of accountants and the requirements for accountants' reports.
Article 3—General Instructions as to Financial Statements. Contains the instructions as to the various types of financial statements (e.g., registrant, businesses acquired or to be acquired, significant unconsolidated subsidiaries) required to be filed, and the periods to be covered.
Article 3A—Consolidated and Combined Financial Statements. Governs the preparation of consolidated or combined financial statements by a registrant.
Article 4—Rules of General Application. Contains certain disclosure requirements not provided for by GAAP and also contains accounting rules for registrants engaged in oil- and gas-producing activities.
Article 5—Commercial and Industrial Companies. Contains the instructions regarding the contents of and disclosures for the balance sheet and income statement line items for commercial and industrial companies as well as the requirements for financial statement schedules.
Articles 6 to 9. Contain financial statement and schedule instructions, in a manner similar to Article 5, for certain special types of entities as listed:

Article 6	Registered Investment Companies
Article 6A	Employee Stock Purchase, Savings, and Similar Plans
Article 7	Insurance Companies
Article 9	Bank Holding Companies

Note that Article 8 on committees issuing certificates of deposit was removed in 1985.

Article 10—Interim Financial Statements. Contains instructions as to the form and content of the interim financial statements required by Article 3 and by the quarterly report on Form 10-Q.
Article 11—Pro Forma Financial Information. Contains presentation and preparation requirements for pro forma financial statements and a financial forecast filed in lieu of a pro forma statement of income.
Article 12—Form and Content of Schedules. Sets out the detailed requirements for the various financial statement schedules required by Articles 5, 6, 6A, 7, and 9.

(b) Accountants' Reports

The form and content of accountants' reports are prescribed by Rule 2-02 of Regulation S-X.

In those situations where other independent accountants have audited the financial statements of any branch or consolidated subsidiary of the registrant, Rule 2-05 of Regulation S-X sets forth the reporting requirements in addition to the requirements set forth in the PCAOB's audit standards. (This section is covered by the interim standards adopted by the PCAOB.) Where part of an audit is made by an independent accountant other than the principal accountant and his or her report is referred to by the principal accountant, or when the prior period's financial statements are audited by a predecessor accountant, the separate report of the other accountant must be included in the filing. However, such separate reports are not required to be included in annual reports to stockholders.

The SEC generally will not accept opinions that are qualified for scope or fairness of presentation. The SEC will reject opinions that contain an explanatory paragraph that addresses the uncertainty of the registrant's ability to recover its investment in specific assets, for example, a significant receivable, an investment security or interest, or certain deferred costs. Since GAAP require such assets to be stated not in excess of their net recoverable amount, the SEC Staff views such modifications as indicative of a scope of limitation (i.e., the auditor was unable to determine that the asset was stated at or below net recoverable value).

However, the SEC will accept an audit report that contains a going-concern paragraph if the filing contains full and fair disclosure as to the registrant's financial difficulties and the plans to overcome them. Also, an audit report with a fourth explanatory paragraph describing an accounting change is acceptable.

Any filings made via EDGAR include a typed signature of the accountant. The registrant is required to keep a manually signed copy of the accountant's report in its files for five years after the filing of the related document.

(c) General Financial Statement Requirements

Article 3 of Regulation S-X establishes uniform instructions governing the periods to be covered for financial statements included in most registration statements and reporting forms filed with the SEC. These are:

Audited balance sheets as of the end of the last two fiscal years
Audited statements of income, comprehensive income, stockholders' equity, and cash flows for each of the last three fiscal years (the same financial statements are required in annual reports to stockholders furnished pursuant to Section 14a-3 of the proxy rules [Regulation 14A])

Additionally, for 1933 Act filings, Article 3, in general, requires in specified circumstances unaudited interim financial statements for a current period along with financial statements for the comparable period of the prior year. It also allows audited statements of income, comprehensive income, stockholders' equity, and cash flows for a nine-month period to substitute for one of the required fiscal year periods in certain specified circumstances or when permitted by the SEC Staff.

Article 3 codifies the Staff position that 1933 Act filings by companies that have not yet completed their first fiscal year must include audited financial statements as of a date within 135 days of the date of the filing.

(d) Consolidated Financial Statements

Rule 3A-02 requires a registrant to file consolidated financial statements that clearly exhibit the financial position and results of operations of the registrant and its subsidiaries. A brief description of the principles followed in consolidating the financial statements and in determining the entities included in consolidation is required to be disclosed in the notes to the financial statements. If there has been a change in the entities included in the consolidation or in their fiscal year-ends, such changes should also be disclosed.

The latest year of consolidated subsidiaries must be within 93 days of the registrant's fiscal year-end. If there are differences in year-end, the registrant must disclose the closing date of the subsidiary and the effect of intervening events that materially affect the financial position or results of operation.

(e) Regulation S-X Materiality Tests

Some of the additional disclosures required by Rules 5-02 and 5-03 of Regulation S-X, based on stated levels of materiality, are summarized next. These disclosures may be made either on the face of the financial statements or in a note.

Notes receivable. Show separately if amount represents more than 10 percent of aggregate receivables.
Other current assets and other assets. State separately any amount in excess of 5 percent of total current assets and total assets, respectively.
Other current liabilities and other liabilities. State separately any amount in excess of 5 percent of total current liabilities and total liabilities, respectively.
Net sales and gross revenues. State separately each component representing 10 percent of total sales and revenues.

(f) Chronological Order and Footnote Referencing

The SEC has no preference as to the chronological order (i.e., left to right or right to left) used in presenting the financial statements. However, the same order must be used consistently throughout the filing, including numerical data in narrative sections.

The financial statements are not required to be referenced to applicable notes unless it is appropriate for an effective presentation.

(g) Additional Disclosures Required by Regulation S-X

Regulation S-X requires certain significant disclosures to the financial statements not required by GAAP. A summary of the most common additional requirements (exclusive of those relating to specialized industries) is presented next. However, if amounts involved are immaterial, disclosures may be omitted.

Assets subject to lien (Rule 4-08(b)). The nature and approximate amount of assets mortgaged, pledged, or subject to liens and an identification of the related obligation.
Restrictions on the payment of dividends (Rule 4-08(e)). A description of the most restrictive limit on the payment of dividends by the registrant and the amount of retained earnings or net income restricted or free of restrictions. Additionally, the amount of consolidated retained earnings representing the undistributed earnings of 50-percent-or-less-owned equity method investees must be disclosed. As discussed in more detail later in this section, disclosure may also be required of restrictions on the ability of subsidiaries to transfer funds to the parent, and in some cases separate parent-company-only financial information may be required. The disclosure requirements are based on specified materiality tests.
Financial information of unconsolidated subsidiaries and 50-percent-or-less-owned equity method investees (Rules 3-09 and 4-08(g)). This requirement is discussed in detail later in this section.
Related party transactions (Rules 1-02(t) and 4-08(k)). Regulation S-X requires disclosure of material related party balances on the face of the balance sheet, income statements, and statement of cash flows (in addition to the footnote disclosures required by GAAP).
Income taxes (Rule 4-08(h)). The additional SEC disclosures relating to income taxes are discussed in Sections 5.1(d) and 5.2(k).
Redeemable preferred stock (Rule 5-02(28)). The presentation and disclosure requirements for preferred stocks or other equity securities having certain mandatory redemption features are discussed in Section 5.4(m).
Defaults (Rule 4-08(c)). Disclose the facts and amounts concerning any default in principal, interest, sinking fund, or redemption requirement, or any breach of a covenant that has not been cured. If a waiver has been obtained, the registrant must state the amount involved and the period of the waiver.
Warrants or rights outstanding (Rule 4-08(i)). Disclose the title and aggregate amount of securities underlying warrants or rights outstanding; and the date and price at which the warrants or rights are exercisable.
Accounting policies for certain derivative instruments (Rule 4-08(n)). Disclose the accounting policies used for derivative financial instruments and derivative commodity instruments and the methods of applying these policies that materially affect the determination of financial position, cash flows, or results of operations. The disclosure should include:

a. A discussion of the methods used to account for derivatives

b. The types of derivatives accounted for under each method

c. The criteria required to be met for use of each accounting method

d. The accounting method used if the specific criteria are not met

e. The accounting for the termination of derivatives designed as hedges

f. The accounting for derivatives if the designated item matures or is otherwise terminated

g. Where and when derivatives and their related gains and losses are reported in the financial statements

(h) Other Sources of Disclosure Requirements

The SEC publishes the opinions of the Commission on major accounting questions and on the form and content of financial statements and financial disclosures in FRRs. These opinions (originally called Accounting Series Releases), which supplement Regulations S-X and S-K, have been codified by the SEC to present their contents in an organized manner. The SEC's “Codification of Financial Reporting Policies” contains all current releases relating to financial statement information.

SABs are interpretations and practices followed by the Division of Corporation Finance and the Office of the Chief Accountant. SABs are not SEC rules; instead, they are a means of documenting the SEC Staff's views on matters relating to accounting and disclosure practices. An SAB usually deals with a specific question posed to the SEC relating to a specific situation. However, the Staff has indicated that the guidance included in the SABs should be applied in similar cases. Although the SABs are not formal rules of the SEC, they do reflect the Staff's current thinking and represent the position that will be taken on various accounting and disclosures matters. As a result, SABs should be followed when preparing information to be included in a filing with the SEC.

The SLBs reflect the views of the SEC Staff but are not rules or regulations (similar to SABs).

(i) Restrictions on Transfer by Subsidiaries and Parent-Company-Only Financial Information

Regulation S-X emphasizes the disclosure of restrictions on subsidiaries' ability to transfer funds to the parent by requiring these disclosures in certain instances:

Footnote disclosure describing and quantifying the restrictions on the subsidiaries (Rule 4-08(e)).
Condensed parent-company-only financial information as a financial statement schedule (Rules 5-04 and 12-04).

The next footnote disclosures are required when the sum of (1) the proportionate share of subsidiaries' consolidated and unconsolidated net assets (after intercompany eliminations) that are restricted from being loaned or advanced, or paid as a dividend to the parent without third party consent and (2) the parent's equity in undistributed earnings of 50-percent-or-less-owned equity method investees exceed 25 percent of consolidated net assets as of the latest fiscal year-end:

Any restrictions on all subsidiaries' ability to transfer funds to the parent in the form of cash dividends, loans, or advances
The separate total amounts of consolidated and unconsolidated subsidiaries' restricted net assets at the end of the latest year

In addition, the rules require presentation of condensed parent company financial position, results of operations, and cash flows in a financial statement schedule (Schedule I) when the restricted net assets of consolidated subsidiaries exceed 25 percent of consolidated net assets at the end of the latest year (Rules 5-04 and 12-04). The condensed data may be in Form 10-Q format and should disclose, at a minimum, material contingencies, the registrant's long-term obligations and guarantees, cash dividends paid to the parent by its subsidiaries and investees during each of the last three years, and a five-year schedule of maturities of the parent's debt.

In determining the amount of restricted net assets, where the limitations on funds that may be loaned or advanced differ from any dividend restriction, the least restrictive amount should be used in the computation. For example, if a subsidiary is prohibited from paying dividends but can lend funds to the parent without limitation, the subsidiary's net assets will be considered unrestricted. Illustrations of situations involving restrictions may include loan agreements that require a subsidiary to maintain certain working capital or net assets levels. The amount of the subsidiary's restricted net assets should not exceed the amount of its net assets included in consolidated net assets. (Acquisition of a subsidiary in a “purchase” transaction can result in a significant difference in this regard.) Furthermore, consolidation adjustments should be pushed down to the subsidiary for the purpose of this test.

In computing net assets, redeemable preferred stock and noncontrolling interests should be excluded from equity.

(j) Financial Information Regarding Unconsolidated Subsidiaries and 50-Percent-or-Less-Owned Equity Method Investees

Depending on their significance, Regulation S-X can require the presentation of both:

Footnote disclosure of summarized financial statement information for unconsolidated subsidiaries and 50-percent-or-less-owned equity method investees
Separate financial statements for one or more unconsolidated subsidiaries or 50-percent-or-less-owned equity method investees

It should be noted that under GAAP, unconsolidated subsidiaries that are not consolidated generally consist of a relatively narrow group of subsidiaries for which control is temporary or ineffectual.

Summarized financial statement footnote information as to assets, liabilities, and results of operations of unconsolidated subsidiaries and 50-percent-or-less-owned equity method investees is required when any one of the next tests—significant subsidiary tests of Rule 1-02(w)—are met on an individual or aggregate basis (Rule 4-08(g)).

Investment test. The amount of the registrant's and its other subsidiaries' investments in and advances to such subsidiaries and other companies exceeds 10 percent of the total assets of the parent and its consolidated subsidiaries as shown in the most recent consolidated balance sheet. For a proposed business combination to be accounted for as a pooling of interests, this condition is also met when the number of common shares exchanged or to be exchanged exceeds 10 percent of the registrant's total common shares outstanding at the date the combination is initiated.
Asset test. The amount of the registrant's and its other subsidiaries' proportionate share of the total assets (after intercompany eliminations) of such subsidiaries and other companies exceeds 10 percent of the total assets of the parent and its consolidated subsidiaries as shown in the most recent consolidated balance sheet.
Income test. The registrant's and its other subsidiaries' equity in the income from continuing operations before income taxes and extraordinary items and cumulative effect of an accounting change of such subsidiaries or other companies exceeds 10 percent of the income of the registrant and its consolidated subsidiaries for the most recent fiscal year. However, if such consolidated income is at least 10 percent lower than the average of such income for the last 5 fiscal years, then the average income may be substituted in the determination. Any loss year should be excluded when computing average income. Additionally, when preparing the income statement test on an aggregate basis, unconsolidated subsidiaries, and 50-percent-or-less-owned equity method investees that report losses should not be aggregated with those reporting income.

According to Rule 1-02(bb), the summarized information should include:

For financial position. Current and noncurrent assets and liabilities, redeemable preferred stock, and minority interests. In the case of specialized industries where classified balance sheets ordinarily are not presented, the major components of assets and liabilities should be shown.
For results of operations. Gross revenues or net sales, gross profit, income (loss) from continuing operations before extraordinary items and cumulative effect of accounting changes, and net income (loss).

The summarized data is required for the same periods as the audited consolidated financial statements (insofar as it is practicable). In presenting the data, unconsolidated subsidiaries should not be combined with 50-percent-or-less-owned investees. Furthermore, if the significant subsidiary test is met, the summarized information should be provided for all such companies.

In addition to the requirement for footnote disclosure of summarized financial information, separate financial statements are required for any unconsolidated subsidiary or 50-percent-or-less-owned equity method investee that individually meets the Rule 1-02(w) test using 20 percent instead of 10 percent. These separate statements should cover, insofar as is practicable, the same periods as the audited consolidated financial statements and should be audited for those periods in which the 20 percent test is met.

The SEC has eliminated the asset test when determining whether separate audited financial statements of all (both domestic and foreign) equity investees must be provided under Reg. S-X rule 3-09. However, it should be noted that the SEC did not change the Reg. S-X Rule 4-08(g) requirement to provide summary financial information in the notes to the financial statements if equity investees are significant based on any of the three (i.e., assets, investment, and income) significance tests.

Combined or unconsolidated financial statements may be presented when two or more unconsolidated subsidiaries, or two or more 50-percent-or-less-owned investees, meet the 20 percent test.

The inclusion of those separate financial statements required by Rule 3-09 does not eliminate the need to present summarized footnote information pursuant to Rule 4-08(g), and the existence of one 20 percent entity will also automatically trigger the footnote disclosure of summarized information for all entities on an aggregate basis.

Next are listed two informal interpretations by the SEC Staff of the significant subsidiary test under Rule 1-02(w)(2):

1. Rule 1-02(w)(2) of Regulation S-X states that a subsidiary is significant if the parent's (registrant's) and its other subsidiaries' proportionate share of the total assets (after intercompany eliminations) of the subsidiary exceeds 10 percent of consolidated assets.

The next interpretations are directed to the phrase after intercompany eliminations. The term tested subsidiary (used later) refers to the subsidiary being tested to determine whether it is a significant subsidiary. Receivables of the tested subsidiary from members of the consolidated group should be eliminated before determining the consolidated group's proportionate share of total assets of the tested subsidiary. Receivables from unconsolidated subsidiaries and 50-percent-or-less-owned persons of the tested subsidiary should not be eliminated before determining the consolidated group's proportionate share of total assets of the tested subsidiary.

No adjustments would be made to consolidated assets included in the denominator of the fraction, because all appropriate intercompany eliminations are already made in consolidation. Although the phrase after intercompany eliminations is not used in Rule 1-02(w)(3), adjustments to income from continuing operations before income taxes for intercompany profits should be made to the entity being tested similar to those made in recording earnings of the entity in consolidation.

2. Rule 1-02(w)(3) states that a subsidiary is significant if the parent's and its other subsidiaries' equity in the income from continuing operations before income taxes, extraordinary items, and cumulative effect of an accounting change of the subsidiary exceeds 10 percent of such income of the parent and its consolidated subsidiaries, provided that if such income of the parent and its consolidated subsidiaries is at least 10 percent lower than the average of such income for the last five fiscal years such average may be substituted in the determination.

The alternative five-year average income substitution is applicable only to the parent and its consolidated subsidiaries and is not applicable to the subsidiary being tested. In computing the five-year average income, loss years should be assigned a zero, and the denominator should be 5.

In situations where there is a loss figure for one but not both sides of the equation in the computation of the income test, the income test should be made by determining the percentage effect of the parent's and its other subsidiaries' equity in the income or loss from continuing operations before income taxes, extraordinary items, and the cumulative effect of an accounting change of the tested subsidiary on the income or loss of the parent and its subsidiaries (excluding the income or loss of the tested subsidiary).

(k) Disclosure of Income Tax Expense

Rule 4-08(h) of Regulation S-X requires detailed disclosures relating to income tax expense. These rules originally required significant additional disclosures as compared to GAAP; however, since the issuance of the SEC's rules, GAAP has changed and includes almost all of the same requirements so there are minimal incremental requirements. Registrants should disclose:

The components of income before income tax expense as either domestic or foreign if the foreign amount equals or exceeds 5 percent of total income before income tax expense
The components of the income tax expense (i.e., current and deferred) stating separately the amounts applicable to U.S. federal, foreign, and other income taxes, if foreign or other income taxes equal or exceed 5 percent of the tax expense component
The components of deferred tax liabilities (i.e., depreciation, warranty costs)
A reconciliation (in dollars or percentages) between the reported income tax expense and the amount computed by multiplying income by the statutory federal rate, showing separately any item that exceeds 5 percent of the amount computed by multiplying income before tax by the applicable statutory federal tax rate

In those cases where the registrant is a foreign entity, the statutory rate prevailing in the foreign country should be used in making the reconciliation from the statutory rate to the effective rate.

(l) Disclosure of Compensating Balances and Short-Term Borrowing Arrangements

Regulation S-X calls for disclosure of compensating balances (Rule 5-02(1)) and short-term borrowing arrangements (Rule 5-02(19)). The purpose of the rules is to provide information on liquidity of the registrant (i.e., short-term borrowings and maintenance of compensating balances) and cost of short-term borrowing.

(i) Disclosure Requirements for Compensating Balances

A compensating balance is that portion of any demand deposit (i.e., certificate of deposit [CD], checking account balance) maintained by a company as support for existing or future borrowing arrangements.

Compensating balances that are legally restricted under an agreement should be segregated on the balance sheet. An example is a situation where a CD must be held for the duration of a loan. If the compensating balance is maintained against a short-term borrowing arrangement, it should be included as a current asset; if held against a long-term borrowing arrangement, it should be treated as a noncurrent asset.

The existence of a compensating balance arrangement, regardless of whether the balance is legally restricted and even if the arrangement is not reduced to writing, requires these six disclosures in the notes to financial statements for the latest fiscal year:

1. A description of the arrangement.

2. The amount of the compensating balance, if determinable (e.g., a percentage of short-term borrowings, a percentage of unused lines of credit, an agreed-upon average balance).

3. The required balance, under certain arrangements, may be expressed as an average over a period of time. The average required amount may differ materially from that held at year-end.

4. Material changes in amounts of compensating balance arrangements during the year.

5. Noncompliance with a compensating balance requirement and possible bank sanctions whenever such sanctions may be immediate and material.

6. Compensating balances maintained for the benefit of affiliates, officers, directors, principal stockholders, or similar parties.

There is a materiality guideline for determining whether disclosure or segregation is required. Usually compensating balances that exceed 15 percent of liquid assets (current cash balances and marketable securities) are considered material.

Some considerations in computing compensating balances include these:

A compensating balance may include funds that would be held in any case as a minimum operating balance. Such operating balances should not be subtracted from the compensating balance. It may be desirable, however, to disclose the dual purpose of such amounts in the footnotes.
Amounts disclosed or segregated in the financial statements should be on the same basis as the cash amounts shown in those statements. However, the book amounts and bank amounts for cash may differ because of outstanding checks, deposits in transit, and funds subject to collection. To reconcile the book and bank accounts, the compensating balance amount agreed to by the bank should be adjusted by the estimated float (i.e., outstanding checks less deposits in transit).

(ii) Disclosure Requirements for Short-Term Borrowings

The notes to financial statements should disclose the weighted average interest rate on short-term borrowings outstanding as of the date of each balance sheet presented if significant; and the amount and terms of unused lines of credit (Rule 5-02(19)). There must be separate disclosure for lines that support a commercial paper borrowing or similar arrangement. If a line of credit may be withdrawn under certain circumstances, this situation also must be disclosed.

A company may maintain lines of credit with a number of banks. If the aggregate amount of credit lines exceeds the debt limit under any one agreement, only the usable credit should be disclosed.

(m) Redeemable Preferred Stock

Rules 5-02(28), (29), and (30) require that amounts relating to equity securities should be separately classified as (1) preferred stock with mandatory redemption requirements, (2) preferred stock without mandatory redemption requirements, and (3) common stock. Redeemable preferred stock, or another type of stock with the same characteristics, may not be concluded under the general heading of “stockholders' equity” or combined with other stockholders' equity captions, such as additional paid-in capital and retained earnings.

The rule defines redeemable preferred stock as any class of stock (not just preferred) that (1) the issuer undertakes to redeem at a fixed or determinable price on a fixed or determinable date or dates, (2) is redeemable at the option of the holder, or (3) has conditions for redemption that are not solely within the control of the issuer, such as provisions for redemption out of future earnings.

The rule also requires registrants to provide a general description of each issue of redeemable preferred stock, including its redemption terms, the combined aggregate amounts of expected redemption requirements each year for the next five years, and other significant features similar to those for long-term debt.

The rules do not require any change in the calculation of debt/equity ratios for the purpose of making materiality computations to determine if an item requires disclosure or for determining compliance with existing loan agreements. However, where ratios or other data involving amounts attributable to stockholders' equity are presented, such ratios or other data should be accompanied by an explanation of the calculation. If the amounts of redeemable preferred stock are material and the ratios presented are calculated treating the redeemable preferred stock as equity, the ratios should also be presented as if the redeemable preferred stock were classified as debt.

According to SAB Topic 3-C Redeemable Preferred Stock, when preferred stock is issued for less than its mandatory redemption value, the stated value should be increased periodically by accreting the difference, using the interest method, between stated value and the redemption value. The periodic accretions should be included with cash dividend requirements of preferred stock in computing income applicable to common stock unless the preferred stock is a common stock equivalent.

Although Rules 5-02(27)and the related FRR Section 211 speak to preferred stocks that require redemption, the SEC Staff applies those provisions to any equity security that has conditions requiring redemption that are outside the control of the issuer. Several EITF consensus positions (now included in the codification) have applied FRR Section 211, by analogy, to stock purchase warrants and stock issued under certain employee stock plans.

With the general decline in interest rates, it is not uncommon for companies to find that the dividend rates on their outstanding preferred stocks exceed what they believe to be a current rate. The response of many companies in this position has been to either (1) redeem these preferred stocks (typically at a premium to their carrying values), or (2) induce their conversion. As long as redemption of the preferred stock is not outside the control of the issuer (i.e., the security is not a “mandatorily redeemable” preferred stock), accounting practice for such transactions has been to record the excess of (1) the fair value of the consideration transferred to the preferred stockholders over (2) the carrying amount of the preferred stock as a charge to additional paid-in capital. However, the SEC Staff has stated that it believes that such amounts should be treated as reductions of income applicable to common shareholders (in a manner similar to the treatment of dividends on preferred stock) for earnings per share calculation purposes.

(n) Regulation S-X Schedules

The schedules required by Regulation S-X support information presented in the financial statements and can be filed 30 days after the due date of the report as an amendment on Form 10-K/A. Each schedule has detailed instructions as to what information is required. It is essential to understand these instructions and tie the schedules in to the related items in the financial statements. The information required by any schedule may be included in the financial statements and related notes, in which case the schedule may be omitted.

The following schedules are required to be audited if the related financial statements are audited.

Schedule No.	Description
I	Condensed financial information of registrant
II	Valuation and qualifying accounts
III	Real estate and accumulated depreciation
IV	Mortgage loans on real estate
V	Supplemental information concerning property-casualty insurance operations

As noted, certain schedules are required for other specific industries as described in Regulation S-X 6–9.

(o) Regulation S-K

Regulation S-K contains the disclosure requirements for the “textual” (nonfinancial statement) information in filings with the SEC. Regulation S-K is divided into 10 major classifications:

1. General. Including the Commission's policy on projections, rules on incorporation by reference, use of non-GAAP financial measures and smaller reporting companies (Item 10)

2. Business. Including a description of property and legal proceedings (Items 101, 102, and 103)

3. Securities of the registrant. Including market price and dividends (Items 201 and 202)

4. Financial information. Including selected financial data, supplementary financial information, management's discussion and analysis (MD&A) of financial condition and results of operations and disagreements with accountants and market risk disclosures, disclosure controls and procedures and ICFR (Items 301–308)

5. Management and certain security holders. Including directors, executive officers, promoters, and control persons; executive compensation; security ownership of certain beneficial owners and management; and certain relationships and related transactions, code of ethics and corporate governance (Items 401–407)

6. Registration statement and prospectus provisions (Items 501–512)

7. Exhibits (Item 601)

8. Miscellaneous (Items 701–703)

9. List of industry guides (Items 801 and 802)

10. Roll-up transactions (Items 901–915)

(p) Structure of Form 10-K

Form 10-K comprises four parts that are structured to facilitate incorporation by reference from the annual stockholders' report and the proxy statement for the election of directors. This format reflects the SEC's ongoing program of promoting the integration of reporting requirements under the 1933 and 1934 Acts. The parts of the Form 10-K are as follows:

Part I
Item 1	Business
Item 1A	Risk Factors
Item 1B	Unresolved Staff Comments
Item 2	Properties
Item 3	Legal Proceedings
Item 4	Reserved
Part II
Item 5	Market for Registrant's Common Equity and Related Stockholder Matters
Item 6	Selected Financial Data
Item 7	Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A	Quantitative and Qualitative Disclosures about Market Risk
Item 8	Financial Statements and Supplementary Data
Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
Item 9A	Controls and Procedures
Part III
Item 10	Directors and Executive Officers of the Registrant
Item 11	Executive Compensation
Item 12	Security Ownership of Certain Beneficial Owners and Management
Item 13	Certain Relationships and Related Transactions
Item 14	Principal Accounting Fees and Services
Part IV
Item 15	Exhibits and Financial Statement Schedules

(i) Part I of Form 10-K

The information called for by Parts I and II may be incorporated by reference from the annual stockholders' report if that report contains the required disclosures. Where information is incorporated by reference, Form 10-K should include a cross-reference schedule indicating the item numbers incorporated and the related pages in the referenced material. The cross-referencing would be included on the cover page and in Item 14 of Form 10-K.

Item 1—Business (Item 101 of Regulation S-K).

This caption requires the disclosures specified by Regulation S-K relating to the description of business, which are segregated into the next major categories:

General development of the business during the latest fiscal year. The registrant should discuss the year organized and its form of organization; any bankruptcy proceedings, business combinations, acquisitions or dispositions of material assets not in the ordinary course of business; and any changes in the method of conducting its business.
Financial information about industry segments for the last three fiscal years (or for each year the registrant has been engaged in business, whichever period is shorter). If significant trends relating to segments are identified in the five-year Selected Financial Data required under Item 6, it may be advisable to include the segment data for the additional years in Item 1.
Narrative description of business. This caption requires a description of the registrant's current and planned business for each reportable segment and should include information on principal products and services, markets, distribution methods, new products, sources and availability of raw materials, patents, seasonality of business, practices relating to working capital items, dependence on major customers, backlog, government contracts, and competition. In addition, research and development activities, number of employees, and compliance with environment-related laws (including disclosure of material estimated capital expenditures for environmental control facilities for the succeeding fiscal year) should be discussed. The number of employees disclosed should be as of the latest practicable data.
Financial information about geographic areas as discussed in Accounting Standard Codification 280 for the last three fiscal years (or shorter period, if applicable). Information should include information about the foreign countries from which the registrant derives revenues and information about any individual material foreign jurisdiction.

Item 1A—Risk Factors (Item 503(c) of Regulation S-K).

A registrant should describe the specific risk factors that an investor should be aware of in evaluating the company and its future prospects.

Item 1B—Unresolved Staff Comments.

This section requires all accelerated filers to disclose in Form 10-K unresolved comments from the SEC Staff that the issuer believes are material and that are more than 180 days old.

Item 2—Properties (Item 102 of Regulation S-K).

A description of the principal properties owned or leased should be identified. The registrant should briefly discuss the location and general character of the property and indicate any outstanding encumbrances. The industry segments in which the properties are used should be included.

The suitability, adequacy, capacity, and utilization of the facilities should be considered. The SEC has indicated this item will be read in conjunction with the Staff's review of the discussion of “capital resources” in the MD&A (Item 7 of Form 10-K).

Additional information is required for registrants engaged in oil- and gas-producing activities.

Item 3²—Legal Proceedings (Item 103 of Regulation S-K).

This caption primarily requires disclosure of legal proceedings that are pending or that were terminated during the registrant's fourth quarter and involve claims for damages in excess of 10 percent of consolidated current assets. Such disclosure generally includes the name of the court or agency, the date instituted, the principal parties, a description of the factual basis alleged to underlie the proceeding, and the relief sought (if pending). For terminated proceedings, disclosure would include termination date and description of disposition. Disclosure is not required for litigation that is ordinary, routine, and incidental to the company's business.

Environmental actions brought by a governmental authority are required to be disclosed unless the registrant believes that any monetary sanctions will be less than $100,000. Any material bankruptcy, receivership, or similar proceeding of the registrant should also be described.

In determining whether disclosure under Item 3 is required, FRR 36 indicates that amounts a company may be required to pay toward remedial costs do not represent sanctions under Items 103.

Any legal proceedings to which a director, officer, affiliate, or owner of record (actually or beneficially) of more than 5 percent of the voting stock is a party adverse to the registrant should also be disclosed.

Annual Report Disclosure of Certain Tax Penalties

The American Jobs Creation Act of 2004 added Section 6707A to the Internal Revenue Code to (1) provide a monetary penalty for the failure to include on any tax return any information required to be disclosed with respect to certain “reportable” transactions, as described in Section 1.6011-4(b) of the Income Tax Regulations, and (2) require SEC registrants to disclose any such penalties they are required to pay. The Internal Revenue Service issued Revenue Procedure 2005-51 to provide more detailed guidance with respect to the required disclosures. (The requirements are not reflected in any of the SEC's rules or forms.)

(ii) Part II of Form 10-K

Item 5—Market for Registrant's Common Equity and Related Stockholder Matters (Items 201, 701, and 703 of Regulation S-K).

The next information is required under this caption:

The registrant should provide information relating to principal trading markets and common stock prices for the last two years. If the principal market is an exchange (i.e., New York, American, or other stock exchange), the quarterly high and low sales prices should be disclosed. Where there is no established public trading market, a statement should be furnished to that effect. If the principal market is not an exchange (i.e., the securities are traded on the NASDAQ or in the OTC market), the high- and low-bid information should be disclosed.
The approximate number of shareholders for each class of common stock as of the latest practicable date is required to be disclosed.
The frequency and amount of any cash dividends declared on common stock during the past two years and any restrictions on the registrant's present ability to pay dividends are required. If no dividends have been paid, the registrant should so state. When dividends have not been paid in the past although earnings indicated an ability to do so, and the registrant does not intend to pay dividends in the foreseeable future, a statement to that effect should be included under this item. Registrants with a dividend-paying history are encouraged, but not required, to indicate whether dividends will continue in the future. Such forward-looking information is covered by the SEC's safe-harbor rules on projections.
When there are restrictions (including restrictions on the ability of subsidiaries to transfer funds to the registrant) that materially limit the registrant's dividend-paying ability, a discussion of these matters should be included in this caption or should be cross-referenced to the applicable portion of MD&A or to the required disclosures in the notes to the financial statements.
For any sales of unregistered securities sold by the registrant:

a. Securities sold including the title, amount, and date

b. Name of persons or class of persons to whom the securities were sold

c. Consideration received

d. Exemption from registration claimed

e. Terms of conversion if applicable

Registrants that have repurchased shares must provide disclosures covering repurchases made on a monthly basis. Information includes:

a. Total number of shares repurchased

b. Average price paid per share

c. Total number of shares purchased during the month as part of a publicly announced share repurchase plan

d. Maximum number of shares or approximate dollar amount that may yet be purchased under share repurchase plans

Item 6—Selected Financial Data (Item 301 of Regulation S-K).

This item is intended to highlight significant trends in the registrant's financial condition as well as its results of operations. The next summary should be provided, in columnar form, for the last five fiscal years (or shorter period, if applicable) and any additional years necessary to keep the information from being misleading:

Net sales (or operating revenues)
Income (loss) from continuing operations and related earnings per common share data
Total assets
Long-term obligations (including long-term debt, capital leases, and preferred stock subject to mandatory redemption features)
Cash dividends declared per common share (if a dividend was not declared, the registrant should state so)

A registrant may provide additional information to enhance the understanding of, or highlight trends in, its financial position or results of operations. The selected financial data should also include a description of matters that materially affect the comparability of the data (e.g., accounting changes, business combinations, or dispositions) as well as a discussion of material uncertainties that might cause the data not to be indicative of the registrant's future financial condition or operating results.

When a registrant chooses to use a non-GAAP metric, it must include certain additional disclosures including a reconciliation from the non-GAAP metric to the most comparable GAAP metric. Non-GAAP metrics may not be more prominent than that GAAP metric and must describe why the metric is important to users.

Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations (Item 303 of Regulation S-K).

The SEC expects each registrant to tailor the MD&A to its own specific circumstances. As a result there are no prescribed methods of disclosing the required information. The primary focus is centered on the company's earnings, liquidity, and capital resources for the three-year period covered by the financial statements. MD&A may also include other relevant information that promotes an understanding of a registrant's financial condition, changes in financial condition, or results of operations.

The use of boilerplate analysis is discouraged. MD&A should not merely repeat numerical data, such as dollar or percentage changes, contained in or easily derived from the financial statements. Instead, the registrant should provide meaningful commentary as to why changes in liquidity, capital resources, and operations have occurred. The reasons an expected change did not occur should also be included. The emphasis should be on trends, regardless of whether they are favorable or not.

The discussion on each topic should not be solely from a historical perspective. A registrant must also discuss any known trends, demands, commitments, events, or uncertainties that are reasonably likely to have a material effect on future financial condition, liquidity, or results of operations (such as unusually large promotional expenses, large price increases, and strikes).

The SEC's continuing focus on the importance of MD&A attained a new level in 1992 with the first-ever enforcement action taken solely due to the inadequacy of MD&A disclosures. While the SEC has tacked on MD&A deficiency allegations in previous cases of improper financial reporting, In the Matter of Caterpillar, Inc. (Accounting and Auditing Enforcement Release No. 363), there was no financial reporting question.

Seriously deficient MD&As may result in an enforcement action, even if the financial statements and other narrative disclosures are in compliance. Companies would be wise to review their procedures for complying with the MD&A requirements. Particular issues that should be evaluated include:

The adequacy of “systems” in place to gather the information necessary to prepare MD&A (this would include both information about past results and information about known trends, demands, commitments, events, or uncertainties)
The extent to which matters that are significant enough to require discussion at the board of directors level are considered for disclosure in MD&A
The extent to which the company's MD&A does more than update boilerplate and provides the investor with an opportunity to see the company “through the eyes of management”

In 1989, the SEC completed an MD&A project that was intended to study MD&As in actual filings to determine what could be done to improve the information therein. An interpretive release (FRR 36) providing guidance for the improvement of MD&A was issued on May 18, 1989. FRR 36 and Accounting Series Release (ASR) No. 299 contain examples illustrating particular points that the Staff believes require emphasis. This study is still relevant and, along with additional interpretive releases, provides the basis for many of the Staff's comments related to MD&A. The next discussion of the financial areas that are to be addressed in MD&A incorporates this guidance.

Liquidity and capital resources. Liquidity and capital resources may be discussed together because of their interrelationship. Disclosure is required of internal and external sources of liquidity.

In this context, liquidity relates to a company's ability to generate sufficient cash flow on both a long-term and short-term basis. The liquidity discussion should go beyond a review of working capital at specific dates or a mechanical analysis of changes in cash flows. It should cover sources of liquidity, trends, or unusual demands indicating material changes in liquidity and remedial action required to meet any projected deficiencies. The discussion of liquidity should not be limited to cash flow. The registrant should consider changes in other working capital items and future sources of liquidity, such as financing capabilities and securities transactions.

The Staff will expect companies to discuss liquidity trends that may not be obvious from the balance sheet. For example, if a company pays off its line of credit at year-end due to the business cycle but is dependent on it during the year, it needs to provide information so that an investor understands the significance of the line of credit or short-term borrowings to the registrant.

For entities with going-concern opinions, the registrant should disclose its financial difficulties and plans to overcome the difficulties and provide a detailed discussion of its ability or inability to generate sufficient cash to support its operations during the 12-month period following the date of the financial statements.

Indicators of liquidity should be disclosed in the context of the registrant's particular business. For example, working capital may be an appropriate measure of liquidity for a manufacturing company but might not be so for a bank. Even if working capital is considered to be a measure of a company's liquidity, indicators ordinarily should go beyond working capital. Depending on the nature of the company, liquidity indicators may also include unused credit lines, debt–equity ratios, bond ratings, and debt covenant restrictions.

If the financial statements, as required by Regulation S-X, disclose restrictions on the ability of subsidiaries to transfer funds to the parent, the liquidity discussion should indicate the impact of these restrictions on the parent.

Capital resources are not specifically defined by the Commission, but equity, debt, and off-balance-sheet financing arrangements are used as examples. MD&A should describe any material commitments for capital expenditures, their purpose, and the planned source of funds to pay for those capital items. Trends in capital resources, including anticipated changes among the mix of equity, debt, and any off-balance-sheet financing arrangements, should be discussed. Forward-looking information, such as the total anticipated cost of a new plant or the company's overall capital budget, is encouraged by the SEC but not required. Although this information would be useful and is expressly covered by the SEC's safe-harbor rule for projections, the advisability of including such information ordinarily should be reviewed with legal counsel. Known data that will have an impact on future operations (e.g., known increases in labor or material costs, commitments for capital expenditures) is not considered forward-looking data and is required to be disclosed.

Income taxes can have a material impact on the cash flows of the company, so therefore generally they are an item that should be discussed. The income tax footnote provides a reconciliation from the statutory rate to the effective rate, but it does not provide any context for the reconciling items and whether that effective rate will continue in the future. Registrants with material taxes should include some of these discussions in the MD&A. Also for net deferred tax assets, if material, the registrant should discuss uncertainties surrounding realization of the assets and management assumptions.

Results of operations. A description is required of any unusual or infrequent events or transactions and any trends or uncertainties that are expected to affect future sales or earnings. The extent to which sales changes are attributable to volume and prices also should be described. In addition, events that management expects to cause a material change in the relationship between costs and revenues should be discussed, along with the expected change. Registrants should also disclose if they expect inflation to have a material impact on the financial statements.

The SEC believes that, in some cases, a discussion of interrelationships may be the most helpful way of describing the reasons for changes in several individual items. For example, certain costs may be directly related to sales, so a discussion of the reasons for a change in sales may also serve to explain the changes in a related item. A repetition of the same explanation is neither required nor useful.

The SEC has been very focused on disclosures related to segments. It believes that MD&A should adequately explain variances on a segment-by-segment basis. MD&A should also highlight any instances where a segment contributes a disproportionate amount of income or loss as compared to its revenue levels.

The Commission has stated that its focus on MD&A disclosures will continue, and principal targets of enforcement will include the failure of companies to address continued operating trends and financial institutions not candidly addressing loan loss problems. The SEC has also warned that the antifraud provisions applicable to filings under the Securities Acts also apply to all public statements made by persons speaking on behalf of the registrant. Therefore, company spokespersons should exercise care when making statements that can reasonably be expected to be made known to the financial community and ultimately relied on by the public investor.

For Accounting Standards Updates that have been issued but not yet adopted, a brief description of the standard and its anticipated adoption date, the method of adoption and impact on the financial statements to the extent reasonably estimable is required.

Contractual obligations. In a separately captioned section of the MD&A, tabular disclosure must be provided about these types of contractual obligations:
- Long-term debt
- Capital leases obligations
- Operating leases
- Purchase obligations
- Other long-term obligations reflected on the balance sheet.

Amounts due in less than one year, one to three years, three to five years, and more than five years must be provided for each category. In addition, the table should be accompanied by footnotes necessary to describe material contractual provisions or other material information to the extent necessary for an understanding of the timing and amount of the contractual obligations.

Additional interpretive guidance. The SEC issued FRR 72 to provide guidance regarding MD&A. The release does not create new legal requirements or modify existing legal requirements but provides guidance to help companies prepare MD&A disclosure that is easier for an investor to understand and that better satisfies the SEC's stated objectives.

The guidance reminds companies of existing disclosure requirements and provides additional guidance regarding the overall presentation and focus of MD&A. Suggestions for improved presentation include:

Use of an executive-level overview
Tabular presentation of relevant financial or other information
Deletion of information carried forward from past-years' MD&A that is no longer relevant
Reformatting the MD&A to discuss the most significant items first
Emphasis on analysis of financial information as opposed to simply discussion (i.e., the underlying reasons for and implications of material trends, events, demands and commitments, and uncertainties)
Discussion of known material trends and uncertainties, including quantification of their material effects to the extent the information is reasonably available
Use of key performance indicators, including both financial and nonfinancial measures.
Liquidity and capital resources. Specifically, suggesting registrants focus on the cash requirements (using the table of contractual obligations as a starting point) and the sources of cash to satisfy the requirements

Critical accounting policies. The SEC provided guidance regarding the need to disclose critical accounting policies in FRR 60 (Release No. 33-8040), Cautionary Advice Regarding Disclosure about Critical Accounting Policies. To elicit improved disclosure in this area, in April 2002, the SEC proposed rules that are contained in Release No. 33-8098, Proposed Rule: Disclosure in Management's Discussion and Analysis about the Application of Critical Accounting Policies. That proposal would mandate presenting this information in a separate section of MD&A.

Both FRR 60 (Release No. 33-8040) and the proposed rule discuss that companies should provide disclosure in MD&A that allows investors to understand the manner and degree to which the reported operating results, financial condition, and changes in financial condition depend on estimates involved in applying accounting policies that entail uncertainties and subjectivity. To do this, a company should provide disclosures about (1) the critical accounting estimates it made in applying its critical accounting policies and (2) the initial adoption of an accounting policy that has a material impact on its financial presentation. The disclosures should focus on the most recent fiscal year and any subsequent interim period presented. Currently, many companies present this information in a separate section of the MD&A immediately preceding or following the discussion of the results of operations.

Since final rules have not been issued on critical accounting policies and estimates, FRR 60 is the official applicable guidance. However, the Staff believes that the postponed rules in Release No. 33-8098 also call for disclosures that investors will find useful. Therefore, registrants should also consider the items called for in that proposal when preparing their disclosures.

Critical accounting policy disclosures should communicate uncertainties and how they might affect the financial statements. The Staff commented that repeating disclosure from the accounting policies footnote does not satisfy the MD&A requirements to disclose known uncertainties that are reasonably likely to materially affect future operating results. Critical accounting estimates disclosure should focus on numbers in the financial statements that are sensitive to material change from external factors. The disclosure should provide insight into:

The assumptions used in deriving estimates, particularly those that factor into fair value estimations
How the estimate was arrived at, including all assumptions that factored into the initial estimate and how susceptible the estimate is to variability
If any of the assumptions have changed from the prior period, the reason for the change and resulting impact on the estimate
Factors that could cause the estimate to change in the future and the potential magnitude of future changes

Item 7A—Quantitative and Qualitative Disclosures About Market Risk (Item 305 of Regulation S-K).

The disclosures must be made in all filings containing annual financial statements. Summarized quantitative disclosures must also be provided for the preceding fiscal year, although comparative information is not required for the first fiscal year in which the information is presented.

The quantitative and qualitative disclosures are intended to help investors better understand specific market risk exposures of registrants, thereby allowing them to better manage market risks in their investment portfolios.

Item 305 requires separate disclosures for instruments entered into for trading purposes and for purposes other than trading

In addition, within each of these portfolios, market risk must be described separately for each category of risk (e.g., interest rate risk, foreign currency exchange rate risk, and commodity price risk). Materiality is to be evaluated based on both:

The materiality of the fair values of the market risk-sensitive instruments outstanding at the end of the latest fiscal year
The materiality of potential near-term (generally up to one year) losses in future earnings, fair values, and cash flows from reasonably possible near-term changes in market rates or prices

If market risk is determined to be material under either definition (present or future), market risk disclosures are required.

Based on this definition of materiality, entities with no derivatives (e.g., banks with significant fixed rate loans outstanding, entities with material amounts of marketable securities, or entities with receivables or payables denominated in foreign currencies) will be required to make Item 305 disclosures.

Quantitative disclosures. The quantitative information requirements are very detailed and specific. In summary, the information can be disclosed in three different ways. The alternatives are:

a. A tabular presentation that shows fair values, contract terms, and expected future cash flow amounts for market risk-sensitive instruments

b. A sensitivity analysis showing the potential loss in future earnings, fair values, or cash flows of market risk-sensitive instruments resulting from one or more selected hypothetical changes in interest rates, foreign currency exchange rates, commodity prices, or other relevant market rate or price changes over a selected period of time

c. Value at risk disclosures that express the potential loss in earnings, fair values, or cash flows of market risk-sensitive instruments over a selected period of time, with a selected likelihood of occurrence, from changes in interest rates, foreign currency exchange rates, commodity prices, or other relevant market rates or prices

The rules provide great flexibility in selecting the method to be used for each portfolio (trading and nontrading) and category of risk. Furthermore, the methods, once selected, can be changed if the registrant discloses the reason for the change and provides comparable disclosures for the current and previous years. Additionally, registrants who believe providing quantitative year-end information may hurt their competitive position may provide the sensitivity analysis or value-at-risk disclosures for the average, high, and low amounts for the fiscal year.

In addition, disclosures regarding the methods and assumptions used are required. Registrants must also discuss (after the initial year) the reasons for material quantitative changes in market risk exposures as compared to the preceding fiscal year.

Registrants are also encouraged, but not required, to provide market risk disclosures regarding market risk-sensitive instruments and transactions other than those specifically required by Item 305 (e.g., commodity positions, anticipated transactions). Disclosures for these items may be combined with the disclosures for the required instruments. Disclosure for these items is suggested, but not required. Because their cash flows may be difficult to estimate. For example, a U.S. company that imports a significant portion of the products it sells from Japan may find it difficult to estimate the impact on anticipated transactions of changes in the yen/dollar exchange rate.

Registrants are therefore also required to discuss limitations that cause the quantitative information to not fully reflect the market risk exposures of the entity. Such limitations include (1) failing to provide the voluntary disclosures discussed in the preceding paragraph and (2) the fact that market risks related to leverage, options, or prepayment features may not be fully communicated through the required disclosures.

The SEC believes that much of the information to prepare the tabular presentation is currently available and that the additional recordkeeping costs to implement this approach should not be great, particularly since (1) financial institutions already disclose a significant amount of the information required in a tabular presentation pursuant to Industry Guide 3 and (2) the tabular presentation alternative is similar to the gap analysis commonly provided by financial institutions. However, the SEC believes that the sensitivity analysis or value at risk disclosure alternatives may require significant additional costs if a registrant does not already use one of these methodologies to manage market risk.

Qualitative disclosures. The qualitative disclosures are intended to make the quantitative information more meaningful by placing it in the context of the registrant's business. Registrants are required to describe (1) the primary market risk exposures at the end of the latest fiscal year, (2) how those exposures are managed (i.e., description of objectives, strategies, and instruments, if any, used), and (3) known or expected changes in exposures or risk management practices as compared to those in effect during the most recently completed fiscal year.

The Private Securities Litigation Reform Act of 1995 established a safe harbor from liability in private lawsuits for certain forward-looking statements. This safe harbor was extended to the Item 305 disclosures. The safe harbor does not apply to financial statements, so the Item 305 disclosures must be made outside the financial statements.

Item 8—Financial Statements and Supplementary Data.

Financial statements. Article 3 of Regulation S-X contains uniform instructions governing the periods to be covered by financial statements included in annual stockholders' reports and in most 1933 Act and 1934 Act filings. The basic financial statement requirements for Form 10-K are:
- Audited balance sheets as of the end of the most recent two fiscal years
- Audited statements of income, comprehensive income, changes in stockholders' equity, and cash flows for the most recent three fiscal years

These financial statements may be incorporated into the 10-K by reference from the annual stockholders' report.

The financial statement schedules required by Regulation S-X, as well as any separate financial statement required by Rule 3-09, are not included in Item 8 but instead are presented in Item 14.

Supplementary financial information (Item 302 of Regulation S-K).
- Selected quarterly financial data

The next data are required to be disclosed for each full quarter within the latest two fiscal years and any subsequent interim periods for which income statements are presented:

Net sales, gross profit, income (loss) before extraordinary items and cumulative effect of a change in accounting, per share data based on such income (loss) (basic and diluted) and net income (loss). The registrant may also be required to disclose per share data for discontinued operations, extraordinary items, and net income (losses). SAB Topic 6-G-1 states that companies in specialized industries should, in lieu of “gross profit,” present quarterly data in the manner most meaningful to their industry.
A description of the effect of any disposals of segments of a business and extraordinary, unusual, or infrequently occurring items.
The aggregate effect and nature of year-end or other adjustments that are material to the results of the quarter.
An explanation, in the form of a reconciliation, of differences between amounts presented in this item and data previously reported on Form 10-Q filed for any quarter (e.g., where a pooling of interests occurs or where an error is corrected).

The interim data disclosures are not required for parent-company-only financial statements that are presented in a schedule in Item 14 of Form 10-K. The data also need not be included for supplemental financial statements for unconsolidated subsidiaries or 50-percent-or-less-owned companies accounted for by the equity method unless the subsidiary or affiliate is a registrant that does not meet the conditions for exemption from the disclosure rule. The SEC requires timely quarterly reviews of a company's interim financial statements by its independent auditors prior to the filing of its Form 10-Q with the Commission. The independent auditor is required to follow “professional standards and procedures for conducting such reviews, as adopted or established by the PCAOB, as may be modified or supplemented by the Commission.” These auditing procedures are set forth in Auditing Standards Codification (AU) Section 722, Interim Financial Information, as are the steps an auditor must take when, as the result of performing a review of the interim financial information of a public entity or certain other procedures, the auditor becomes aware that interim financial information filed or to be filed with the SEC is materially misstated.

AU Section 722 requires auditors to perform certain review procedures with respect to the quarterly data. It also provides guidance for an auditor's reporting responsibilities regarding the review of quarterly financial data. Specifically, the auditor's report should be expanded if the quarterly financial data required by Item 302 are (1) omitted or (2) have not been reviewed.

Item 9—Changes in and Disagreements with Accountants on Accounting and Financial Disclosures (Item 304 of Regulation S-K).

The SEC has long been concerned about the relationships between the registrant and its independent accountants. During the 1980s, the growing number of allegations about opinion shopping encouraged the SEC to adopt new disclosure requirements to provide increased public disclosure of possible opinion-shopping situations. In FRR 31, dated April 7, 1988, the Commission stated:

The auditor must, at all times, maintain a “healthy skepticism” to ensure that a review of a client's accounting treatment is fair and impartial. The willingness of an auditor to support a proposed accounting treatment that is intended to accomplish the registrant's reporting objectives, even though that treatment might frustrate reliable reporting, indicates that there may be a lack of such skepticism and independence on the part of the auditor. The search for such an auditor by management may indicate an effort by management to avoid the requirements for an independent examination of the registrant's financial statements. Engaging an accountant under such circumstances is generally referred to as “opinion shopping.” Should this practice result in false or misleading financial disclosure, the registrant and the accountant would be subject to enforcement and/or disciplinary action by the Commission.

In 1986 and 1988, the SEC made significant amendments to Item 304 to require additional disclosures about changes in and disagreements with accountants. Disagreements and “other reportable events” are required to be disclosed in Form 8-K and in proxy statements sent to shareholders. The same disclosures are generally required in Form 10-K. However, if a Form 8-K has been filed reporting a change in accountants and there were no reported disagreements or reportable events, the Form 10-K does not require a repetition of the disclosures.

Item 9A—Controls and Procedures (Items 307 and 308 of Regulation S-K).

Evaluation and Reporting Requirements—Disclosure Controls and Procedures (Item 307). Rules 13a-15(b) and 15d-15(b) require each issuer's management to evaluate, with the participation of the issuer's principal executive and principal financial officers, or persons performing similar functions, the effectiveness of the issuer's disclosure controls and procedures, as of the end of each fiscal quarter (including the fourth quarter). Regulation S-K Item 307 requires disclosure of management's conclusions regarding the effectiveness of the registrant's disclosure controls and procedures.

Evaluation and Reporting Requirements—Internal Control over Financial Reporting (Item 308). The Commission adopted through Release 33-8238 rules to implement Section 404 of Sarbanes-Oxley and require management to evaluate and report on the effectiveness of a registrant's internal controls in each annual report. Among other actions, the rules require

Management (other than that of a registered investment company) to evaluate the effectiveness of the issuer's ICFR as of the end of each fiscal year.

The issuer's principal executive and financial officers must participate. The evaluations must be based on a framework that is a suitable, recognized control framework that has been established by a body or group that has followed due process procedures, including a broad distribution of the framework for public comment. The Committee of Sponsoring Organizations (COSO) framework will satisfy the SEC's criteria. However, the rules do not mandate the use of a particular framework.

The rules do not specify the methods for or procedures to be performed in evaluating ICFR. However, the rules state that in conducting the evaluation and developing an assessment of the effectiveness of internal controls, a company must maintain evidential matter, including documentation, to provide reasonable support for management's conclusions. In addition, inquiry alone will not provide an adequate basis for management's assessment. The assessment must be based on procedures sufficient to both

Evaluate the internal control over financial reporting's design effectiveness and
Test its operating effectiveness.

While nonmanagement personnel may perform this work, management must actively supervise the entire process.

Management to report on a company's internal controls in each annual report. Companies must include in their annual reports a report of management on the company's ICFR (Regulation S-K Item 308(a)). Management reporting on ICFR has been required for all public companies for fiscal years ending on or after December 15, 2007.
The report must include
- A statement of management's responsibility for establishing and maintaining adequate ICFR.
- A statement identifying the framework used by management to evaluate the effectiveness of the company's ICFR.
- Management's assessment of the effectiveness of the company's ICFR as of the end of the company's most recent fiscal year, including a statement as to whether the company's ICFR is effective or not.
- A statement that the registered public accounting firm that audited the company's financial statements has issued an attestation report on the registrant's ICFR.

With regard to management's assessment of the effectiveness of the company's internal controls,

A negative assurance statement indicating that nothing has come to management's attention to suggest that the company's ICFR is not effective is not acceptable.
The report must include disclosure of any material weaknesses in the company's ICFR.
Management is not permitted to conclude that the company's ICFR is effective if there are one or more material weaknesses.
It is the Commission's judgment that an aggregation of significant deficiencies could constitute a material weakness.

The rules do not specify where the internal control report must appear in the company's annual report. Companies typically place the report either in Section 9A, near MD&A disclosure, or in a portion of the document immediately preceding the financial statements.

A company's auditors to issue an attestation report on the registrant's ICFR. The auditor's attestation report must be filed as part of the annual report and should be placed in the same location as management's internal control report (Regulation S-K Item 308(b)). The SEC had temporarily exempted nonaccelerated filers from the ICFR auditor attestation requirement. However, the Dodd-Frank Act, which was signed into law on July 21, 2010, permanently exempted nonaccelerated filers from the requirement to have their auditors attest to their ICFR. In September 2010, the Commission conformed its rules to the Dodd-Frank Act. The SEC now deems the management reports on ICFR of nonaccelerated issuers to be filed, not furnished, and these filers no longer need to provide a statement that an auditors' report on ICFR was not provided.
Management to disclose each quarter (including the fourth quarter) material changes during the quarter in internal controls.
Regulation S-K Item 308(c).
- Registrants must disclose material changes in ICFR that have occurred during a quarter (including the fourth quarter). However, the rules do not require a quarterly report on the effectiveness of a company's internal controls.

Item 9B—Other Information.

The registrant must disclose under this item any information required to be disclosed in a report on Form 8-K during the fourth quarter of the year covered by this Form 10-K, but not reported, whether otherwise required by this Form 10-K or not. If disclosure of such information is made under this item, it need not be repeated in a report on Form 8-K that would otherwise be required to be filed with respect to such information or in a subsequent report on Form 10-K.

(iii) Part III of Form 10-K

The information required in this part may be incorporated by reference from the proxy statement relating to election of directors if such statement is to be filed within 120 days after year-end. If the information is omitted from the Form 10-K and the proxy statement ultimately is not filed within the 120-day period, it will be necessary to amend the Form 10-K by filing a Form 10-K/A to include the omitted information. The reportable information and captions are described in the next subsections.

Item 10—Directors and Executive Officers of the Registrant (Items 401 and 405, 406, and Portions of 407 of Regulation S-K).

The information reportable under this caption includes a listing of directors and executive officers and information about each individual. Directors includes all persons nominated or chosen to become directors. The information includes name, age, positions held with the registrant, business experience for the last five years, other directorships held, and other information that an investor might want to know about an individual serving as an executive officer or director. In addition, as discussed previously, additional disclosures are made related to the audit committee.

The SEC defines executive officers as the president, secretary, treasurer, vice president in charge of a principal function or business, or any person with policy-making functions affecting the entire entity even if he has no title.

Disclosure of family relationships among directors and executive officers and a brief account of their previous business experience for the past five years is also required. Any involvement in certain legal or bankruptcy proceedings during the past five years should be disclosed.

For directors, the registrant must also disclose the particular experience, qualifications, attributes, or skills that led the board to conclude the person should serve as director.

Registrants that were organized within the last five years or that have recently become subject to the reporting requirements of the Exchange Act are also required to disclose certain legal and bankruptcy proceedings that have occurred during the past five years and involve a promoter or control person.

Also, pursuant to Item 405 of Regulation S-K, the registrant must disclose certain information on the identity of officers, directors, or owners of more than 10 percent of any class of stock who during the latest year were late in the filing of any of the “insider trades” reports (Forms 3, 4, and 5) required under Section 16 of the 1934 Act. Pursuant to Item 406, there are additional disclosures related to corporate governance.

Item 11—Executive Compensation (Item 402 and Portions of Item 407 of Regulation S-K).

The SEC executive compensation rules require registrants to disclose information regarding all components of executive and director compensation—not to require any particular practice or regulate the amounts of such compensation. The rules require registrants to report the entire grant date fair value of option and stock awards to executives and directors in the summary compensation table (SCT) and director compensation table (DCT) in the year of grant, regardless of the extent to which the award had vested. Full grant date fair value disclosures are also required in the grants of plan-based awards table. The SEC believes that aggregate grant date fair value disclosure is meaningful to shareholders and better reflects the compensation committee's decision with regard to stock and option awards.

Five named executive officers are included in the SCT. However, the principal executive officer (PEO, formerly the CEO) and the principal financial officer (PFO) are named executive officers regardless of compensation level. The other three named executives are the most highly compensated executive officers identified on the basis of total compensation, not simply salary and bonus. Total compensation for this purpose includes all compensation listed in the SCT except for nonqualified deferred compensation earnings and the accumulated net change in pension value.

Briefly, the principal disclosure requirements include:

SCT provides a three-year summary of compensation paid. It includes annual compensation (salary, bonuses, etc.), earned long-term compensation (including restricted stock awards, the number of options and stock appreciation rights [SARs] granted, long-term incentive plan payouts, and restricted stock holdings), nonequity incentive plan compensation, certain information about pension values, and all other compensation. By requiring information covering three years, this table is designed to provide investors with information to evaluate trends in executive compensation.
The grants of plan-based awards table summarizes the number and terms of options/SARs granted during the last fiscal year. It also requires information about the potential value of the grants as discussed. Outstanding equity awards at fiscal year-end table summarizes information on all equity awards that remain outstanding, unexercised or unearned at year-end.
The option exercises and stock vested table summarizes options exercised and stock awards that vested during the last fiscal year and the aggregate value received.
The postemployment benefits table requires disclosures of the present value of accumulated benefit, the number of years of credited service, and other relevant information.
The nonqualified deferred compensation table includes information about the full amount of nonqualified deferred compensation obligations.
Compensation discussion and analysis (CD&A) requires registrants to analyze and discuss the material factors underlying compensation policies and decisions reflected in the data presented in the tables in the same manner that they discuss operations and financial condition in MD&A.

The Commission provided these key questions that registrants are required to address in their CD&As:

What are the objectives of the company's compensation programs?
What is the compensation program designed to reward?
What is each element of compensation?
Why does the company choose to pay each element?
How does the company determine the amount (and, where applicable, the formula) for each element?
How does each element and the company's decisions regarding that element fit into the company's overall compensation objectives and affect decisions regarding other elements?

The rules also require disclosure of information about compensation of directors, employment contracts and termination agreements, and compensation committee interlocks and insider participation.

Equity Compencation Plans. The information on equity compensation plans should be provided on an aggregate basis and categorized between those plans that were approved by shareholders and those that were not. For each plan that has not been approved by shareholders, the registrant should include a brief description of the material features of the plan. Copies of such plans should also be filed as exhibits unless they are immaterial in amount or significance.

These disclosures are required in annual reports on Forms 10-K and 10-KSB for fiscal years ending on or after March 15, 2002. They are also required in proxy statements for meetings of shareholders occurring on or after June 15, 2002, where the registrant is submitting a compensation plan for shareholder approval.

Item 12—Security Ownership of Certain Beneficial Owners and Management (Items 201(d) and 403 of Regulation S-K).

The next disclosures are required for all equity compensation plans (including individual compensation arrangements) in effect as of the end of the most recent fiscal year:

The number of securities to be issued upon exercise of outstanding options, warrants, and rights
The weighted average exercise price of outstanding options, warrants, and rights
The number of securities remaining available for future issuance under equity compensation plans

The information reportable related to security ownership and certain beneficial owners is required for owners of more than 5 percent of any class of voting securities and for all officers and directors. The name and address of the owner, the amount and nature of beneficial ownership, and the class and percentage ownership of stock should be presented in the prescribed tabular form.

Item 13—Certain Relationships and Related Transactions (Item 404 and 407(a) of Regulation S-K).

Certain transactions in excess of $120,000 must be disclosed that have taken place during the last fiscal year or are proposed to take place, directly or indirectly, between the registrant and any of its directors (including nominees), executive officers, more-than-5 percent stockholders, or any member of their immediate family. In addition, special rules apply to disclosure of payments between the registrant and entities in which directors have an interest (including significant customers, creditors, and suppliers, and law firms or investment banking firms where fees exceeded 5 percent of the firm's gross revenues).

If the registrant is indebted, directly or indirectly, to any individual just mentioned, and such indebtedness has exceeded $120,000 at any time during the last fiscal year, Item 13 requires that the individual, nature of the liability, the transaction in which the liability was incurred, the outstanding balance at the latest practicable date, and other pertinent information be disclosed.

This section of the filing also requires disclosures regarding director independence.

Item 14—Principal Accounting Fees and Services (Item 9(e) of Schedule 14A).

The instructions for this section are found in Item 9(e) of Schedule 14A and call for disclosures related to fees paid to the principal auditor for specific categories: audit fees, audit related fees, tax fees, and all other fees. The disclosures cover the two most recent fiscal years.

(iv) Part IV of Form 10-K

Item 15—Exhibits and Financial Statement Schedules.

This item relates to Regulation S-X schedules, the financial statements required in Form 10-K but not in the annual stockholders' report (i.e., financial statements of unconsolidated subsidiaries or 50-percent-or-less-owned equity method investees, or financial statements of affiliates whose securities are pledged as collateral), and exhibits required by Item 601 of Regulation S-K (including a list of the registrant's significant subsidiaries) and, for electronic filers only, a financial data schedule.

All financial statements, schedules, and exhibits filed should be listed under this item. Where any financial statement, financial statement schedule, or exhibit is incorporated by reference, the incorporation by reference should be set forth in a schedule included in this item.

The financial statement schedules at Item 14 must be covered by an accountant's report. If the financial statements in Item 8 have been incorporated by reference from the annual stockholders' report, Item 14 should include a separate accountant's report covering the schedules. Such a report usually makes reference to the report incorporated by reference in Item 8, indicates that the audit referred to in that report also included the financial statement schedules, and expresses an opinion on whether the schedules present fairly the information required to be presented therein. When the financial statements are not incorporated by reference from the annual report, the 10-K must include an opinion on both the financial statements required by Item 8 and the financial statement schedules required by Item 14. This is accomplished by either of two methods:

1. The report appearing in Item 8 may cover only the financial statements with a separate report included in Item 14 on the financial statement schedules.

2. The report appearing in Item 8 may cover both the financial statements and financial statement schedules by including the schedules in the scope paragraph and by adding a third paragraph that contains an opinion on the schedules.

XBRL Exhibit. In 2008, the SEC adopted amendments that require issuers to provide to the Commission financial statements in interactive data format using Extensible Business Reporting Language (XBRL). The rules apply to public companies and foreign private issuers that prepare their financial statements in accordance with U.S. GAAP and foreign private issuers that prepare their financial statements using IFRS as issued by the IASB. An issuer will be required provide the XBRL data as an exhibit to its annual and quarterly reports, transition reports, Form 8-K and 6-K reports containing updated or revised versions of financial statements that appeared in a periodic report, and registration statements, and on its corporate Web site if it maintains one.

(v) Signatures

The required signatories include the PEO, PFO, controller or principal accounting officer, and at least a majority of the board of directors. The name of each person who signs the report must be typed or printed beneath his or her signature. Signatures for any electronic submission are in typed form rather than manual format. However, manually signed pages (or other documents acknowledging the typed signature) must be obtained prior to the electronic filing. The registrant must retain the original signed version of the document for a period of five years after the filing and provide it to the SEC or the Staff upon request.

(vi) Certifications

The rules require companies to provide Section 302 and 906 certifications as exhibits to the periodic reports to which they relate. The Section 302 certification is exhibit number 31 in the Regulation S-K Item 601 exhibit table; the Section 906 certification is exhibit number 32.

(q) Annual Report to Stockholders

Rules 14a-3 and 14c-3 of the 1934 Act give the SEC the right to regulate the financial statements included in the stockholders' annual report. Although an annual stockholders' report must be sent to the SEC, technically it is not a “filed” document. Therefore, the annual stockholders' report is not subject to the civil liability provisions of Section 18 of the 1934 Act unless it is an integral part of a required filing, such as when incorporated by reference in Form 10-K. Yet an annual stockholders' report is subject to the antifraud provisions set forth in Section 10b and Rule 10b-5 of the 1934 Act. The proxy solicitation (or information statement if proxies are not being solicited) for an annual stockholders' meeting at which directors will be elected must be accompanied or preceded by an annual report that contains:

Audited consolidated balance sheets as of the end of the two most recent fiscal years
Statements of income, comprehensive income (if applicable), shareholders equity, and cash flows for each of the three most recent fiscal years

The requirements of Regulation S-X must be met except for the next rules, which are excluded:

Certain provisions of Article 3 (e.g., financial information for businesses acquired and to be acquired, separate financial statements of subsidiaries not consolidated and 50-percent-or-less owned persons, separate financial statements of guarantors, separate financial statements of affiliates whose securities serve as collateral for the registrant's securities)
Article 11 (pro forma financial information)
Article 12 (financial statement schedules)

The similar disclosure requirements allow registrants to use extensive incorporation by reference to the annual stockholders' report in SEC filings. As such, the annual stockholders' report is often expanded to meet the disclosure requirements of Items 1 through 4 of Form 10-K to allow incorporation by reference. In some cases, the Form 10-K and the annual report are combined into one document.

The annual stockholders' report also must contain a statement, in boldface, that the company will provide the annual report on Form 10-K, without charge, in response to written requests. The report must indicate the name and address of the person to whom such a written request is to be directed. The statement may alternatively be included in the proxy statement.

(i) Content of Annual Report to Stockholders

The SEC has long recognized that the annual stockholders' report is the most effective method of communicating financial information to stockholders. It believes these reports should be readable and informative and prefers that they be written without boilerplate. The SEC allows registrants to use their discretion in determining the format of the annual stockholders' report, as long as the information required is included and can easily be located. To improve the presentation of data, the SEC encourages the use of charts and other graphic illustrations, as long as they are consistent with the information in the financial statements.

5.5 Form 10-Q

In addition to the comprehensive annual report on Form 10-K, the Commission requires a registrant to file a Form 10-Q for each of the first three quarters of its fiscal year. Form 10-Q is due either 40 or 45 days after the end of the quarter depending on accelerated filer status; one is not required for the fourth quarter. If the registrant is a listed company, it also must file Form 10-Q with the appropriate stock exchange. The basic requirements of Form 10-Q are listed next.

The form is required to be filed by any company (1) whose securities are registered with the SEC, and (2) which is required to file annual reports on Form 10-K.
Information must be submitted on a consolidated basis and must be reviewed in accordance with PCAOB auditing standards by the company's independent auditor prior to the filing.

A uniform set of instructions for interim financial statements is included in Article 10 of Regulation S-X, as an extension of the SEC's integrated disclosure program. In addition, certain requirements for the current Form 10-Q are contained in FRR Sections 301, 303, 304, and 305. Interpretations of the rules are provided in SAB Topic 6-G. Accounting Series Releases 177 and 286—Relating to Amendments to Form 10-Q, Regulation S-K, and Regulations S-X Regarding Interim Financial Reporting.

A registrant may elect to incorporate by reference all of the information required by Part I to a quarterly stockholder report or other published document containing the information. Other information also may be incorporated by reference in answer or partial answer to an item in Part II, provided the incorporation by reference is clearly identified. The SEC permits a combined quarterly stockholder report and Form 10-Q if the report contains all information required by Part I and all other information (cover page, signature, Part II) is in the combined report or included on Form 10-Q with appropriate cross-referencing.

(a) Structure of Form 10-Q

Form 10-Q consists of two parts. Part I contains financial information, and Part II contains other information such as legal proceedings and changes in securities.

(i) Part I—Financial Information

Item 1—Financial Statements.

The financial statements should be prepared in accordance with Rule 10-01 of Regulation S-X and ASC 270. An understanding of these requirements is essential in preparing Form 10-Q.

The financial statements may be condensed and should include a condensed balance sheet, income statement, and statement of cash flows for the required periods. The statements are not required to be audited or reviewed by independent accountants.

Balance sheets as of the end of the latest quarter and the end of the preceding fiscal year are required. A comparative balance sheet as of the end of the previous year's corresponding interim date need be included only when, in the registrant's opinion, it is necessary for an understanding of seasonal fluctuations.

Only the major captions set forth in Article 5 of Regulation S-X are required to be disclosed, except that the components of inventory (raw materials, work in process, finished goods) must also be presented on the balance sheet or in the notes. Thus, even if a company uses the gross profit method or similar method to determine cost of sales for interim periods, management will have to estimate the inventory components.

There is also a materiality rule for disclosure of major balance sheet captions. Those that are less than 10 percent of total assets and that have not changed by more than 25 percent from the preceding fiscal year's balance sheet may be combined with other captions.

Income statements for the latest quarter and the year to date and for the corresponding periods of the prior year are to be provided. Statements may also be presented for the 12-month period ending with the latest quarter and the corresponding period of the preceding year.

For example, if a company reports on a November 30, 20XB, fiscal year-end, its Form 10-Q for the quarter ended August 31, 20XB, would include comparative income statements for the nine months ended August 31, 20XB and 20XA, and for the three months ended August 31, 20XB and 20XA.

Only major captions set forth in Article 5 of Regulation S-X are required to be disclosed. However, a major caption may be combined with others if it is less than 15 percent of average net income for the latest three fiscal years and has not changed by more than 20 percent as compared to the related caption in the income statement for the corresponding interim period of the preceding year (except that bank holding companies must present securities gains or losses as a separate item, regardless of the amount or percentage change). In computing average net income, only the amount classified as net income should be used. Loss years should be excluded unless losses were incurred in all three years, in which case the average loss should be used. As with the balance sheet, retroactive reclassification of the prior year is required to conform with the current year's classification in the income statement.

Statements of cash flows for the year to date and for the corresponding period of the prior year are to be presented. In addition, the statement may be presented for the 12-month periods ending with the latest quarter and the corresponding period of the prior year. The statement of cash flows may be condensed, starting with a single amount for net cash flows from operating activities. Additionally, individual items of financing and investing cash flows, and disclosures about noncash investing or financing transactions, need be presented only if they exceed 10 percent of the average net cash flows from operating activities for the last three years. In computing the average, any years that reflect a net cash outflow from operations should be excluded, unless all three years reflect a net cash outflow, in which case the average outflow should be used for the test.

Seven other important provisions of the rules relating to financial information are listed next.

Detailed footnote disclosures and Regulation S-X schedules are not required. However, disclosures must be adequate so as not to make the presented information misleading. It would appear that the two preceding sentences are contradictory. There is, however, a presumption that financial statement users have read or have access to the audited financial statements containing detailed disclosures for the latest fiscal year, in which case most continuing footnote disclosures could be omitted. Regulation S-X specifically requires disclosure of events occurring since the end of the latest fiscal year having a material impact on the financial statements, such as changes in:

a. Accounting principles and practices.

b. Estimates used in the statements.

c. Status of long-term contracts.

d. Capitalization, including significant new borrowings, or modification of existing financing arrangements.

e. If material contingencies exist, disclosure is required even if significant changes have not occurred since year-end.

f. In addition, based on existing pronouncements and informal statements by the SEC, the next matters, if applicable, should be considered for disclosure:

i. Significant events during the period (i.e., unusual or infrequently occurring items, such as material write-downs of inventory or goodwill)

ii. Significant changes in the nature of transactions with related parties

iii. The basis for allocating amounts of significant costs and expenses to interim periods if different from those used for the annual statements

iv. The nature, amount, and tax effects of extraordinary items

v. Significant variations in the customary relationship between income tax expense and income before taxes

vi. The amount of any last-in, first-out (LIFO) liquidation expected to be replaced by year-end or the effect of a material liquidation during the quarter

vii. Significant new commitments or changes in the status of those previously disclosed

Although it is not mentioned in the rules, registrants may consider it desirable to indicate with a legend on Form 10-Q that the financial statements are condensed and do not contain all GAAP-required disclosures that are included in a full set of financial statements. The interim financial statements should contain a statement representing that they reflect all normally recurring adjustments that are, in management's opinion, necessary for a fair presentation in conformity with GAAP. Such adjustments would include estimated provisions for bonuses and for profit-sharing contributions normally determined at year-end.

The registrant may furnish additional information of significance to investors, such as seasonality of business, major uncertainties, significant proposed accounting changes, and backlog. In that connection, ordinarily it would be appropriate to include a statement that the interim results are not necessarily indicative of results to be obtained for the full year. For disposals of a significant portion of the business or for combinations accounted for as purchases, the effect on revenues and net income (including earnings per share) must be disclosed. In addition, in the case of purchases, pro forma disclosures in accordance with ASC 805 are required.

If the prior-period information has been retroactively restated after the initial reporting of that period, disclosure is required of the effect of the change. If an accounting change was made, the date of the change and the reasons for making it must be disclosed. In addition, in the first Form 10-Q filed after the date of an accounting change, a letter from the accountants (referred to as a preferability letter) must be filed as an exhibit in Part II, indicating whether they believe the change to be a preferable alternative accounting principle under the circumstances. If the change was made in response to an FASB requirement, no such letter need be filed.

The SEC Staff acknowledges that where objective criteria for determining preferability have not been established by authoritative bodies, the determination of the preferable accounting treatment should be based on the registrant's business judgment and business planning (e.g., expectations regarding the impact of inflation, consumer demand for the company's products, or a change in marketing methods). The Staff believes that the registrant's judgment and business planning, unless they appear to be unreasonable, may be accepted and relied on by the accountant as the basis of the preferability letter. If circumstances used to justify a change in accounting method become different in subsequent years, the registrant may not change back to the principle originally used without again justifying that the original principle is preferable under current conditions.

Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations (Item 303(b) of Regulation S-K).

The MD&A must be provided pursuant to Item 303(b) of Regulation S-K and should discuss substantially the same issues covered in the MD&A for the latest Form 10-K, specifically focusing on:

Material changes in financial condition for the period from the latest fiscal year-end to the date of the most recent interim balance sheet and, if applicable, the corresponding interim period of the preceding fiscal year
Material changes in results of operations for the most recent year-to-date period, the current quarter, and the corresponding periods of the preceding fiscal year

In preparing the discussion, companies may presume that users of the interim financial information have access to the MD&A covering the most recent fiscal year. The MD&A should address any seasonal aspects of its business affecting its financial condition or results of operations and identify any significant elements of income from continuing operations that are not representative of the ongoing business. The impact of inflation does not have to be discussed.

The MD&A should be as informative as possible. As discussed, the registrant should avoid the use of boilerplate analysis and not merely repeat numerical data easily derived from the financial statements. Information about material changes to contractual obligations should be disclosed.

Item 3—Quantitative and Qualitative Disclosures about Market Risk (Item 305 of Regulation S-K).

Market risk information is required to be presented if there have been material changes in the market risks faced by a registrant or in how those risks are managed since the end of the most recent fiscal year. Interim information is not required until after the first fiscal year-end in which the disclosures are made.

Item 4—Controls and Procedures (Item 307 and 308(c) of Regulation S-K).

Item 4 requires the PEO and PFOs to evaluate the effectiveness of disclosure controls and procedures as of the end of each quarter. Regulation S-K Item 307 requires disclosure of the conclusions of such evaluations.

(ii) Part II—Other Information

The registrant should provide the information below in Part II under the applicable captions. Any item that is not applicable may be omitted without disclosing that fact.

Item 1—Legal Proceedings (Item 103 of Regulation S-K).

A legal proceeding has to be reported in the quarter in which it first becomes a reportable event or in subsequent quarters in which there are material developments. For terminated proceedings, information as to the date of termination and a description of the disposition should be provided in the Form 10-Q covering that quarter.

Item 1A—Risk Factors.

Item 1A requires disclosure of any material changes to the factors reported in response to Item 1A of the issuer's annual report on Form 10-K.

Item 2—Unregistrered Sales of Equity Securities and Use of Proceeds (Item 701 and 703 of Regulation S-K).

Any sales of equity securities not registered under the Securities Act not previously reported, including a description of the securities sold, the purchasers, the consideration received, the exemption from registration claimed, and the terms of conversions (if any), should be disclosed.

For first registration statements filed under the Securities Act, the issuer must report on the use of proceeds in the first periodic report filed after the registration statement's effective date and in each subsequent periodic report (i.e., Form 10-K or 10-Q) until the offering is terminated or all proceeds applied, whichever is later. The registrant must quantify the use of proceeds to date (i.e., to invest in property and plant, to acquire businesses, to repay debt) and identify any direct or indirect payments to directors, officers, or 10 percent or more stockholders.

Registrants are also required to disclose the same information related to repurchases of stock as required in the form 10-K.

Item 3³—Defaults on Senior Securities.

Disclosure is required of a default (with respect to principal or interest) not cured within 30 days of the due date, including any grace period, if the related indebtedness exceeds five percent of consolidated assets. A default relating to dividend arrearages on preferred stock should also be disclosed.

Item 5—Other Information.

Events not previously reported on Form 8-K may be reported under this caption. Such information would not be required to be repeated in a report on Form 8-K.

Item 6—Exhibits and Reports on Form 8-K.

This caption should include a listing of exhibits filed with Form 10-Q (Item 601 of Regulation S-K) and a listing of Form 8-K reports filed during the quarter, showing the dates of any such reports, items reported, and financial statements filed.

Inapplicable exhibits may be omitted without referring to them in the index. Where exhibits are incorporated by reference, that fact should be noted.

XBRL Exhibit. All domestic registrants (foreign private issuers using IFRS will be required to file XBRL schedules as soon as the XBRL taxonomy is approved) are required to include XBRL schedules with the quarterly report.

(iii) Signatures

The form must be signed by the PFO or chief accounting officer of the registrant as well as another duly authorized officer. If the PFO or chief accounting officer is also a duly authorized signatory, one signature is sufficient provided the officer's dual responsibility is indicated.

Signatures for any electronic submission are in typed form rather than manual format. However, manually signed pages (or other documents acknowledging the typed signatures) must be obtained prior to the electronic filing. The registrant must retain the original signed document for a period of five years after the filing of the related document and provide it to the SEC or the staff upon request.

5.6 Form 8-K

(a) Overview of Form 8-K Requirements

A company that is required to file annual reports on Form 10-K is required to file current reports on Form 8-K if any specified reportable events take place. Form 8-K reports are due within four business days after occurrence of the event.

The Form 8-K items are organized in this way:

Section 1—Registrant's Business and Operations
- Item 1.01 Entry into a Material Definitive Agreement
- Item 1.02 Termination of a Material Definitive Agreement
- Item 1.03 Bankruptcy or Receivership
Section 2—Financial Information
- Item 2.01 Completion of Acquisition or Disposition of Assets
- Item 2.02 Results of Operations and Financial Condition
- Item 2.03 Creation of a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement of a Registrant
- Item 2.04 Triggering Events That Accelerate or Increase a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement
- Item 2.05 Costs Associated with Exit or Disposal Activities
- Item 2.06 Material Impairments
Section 3—Securities and Trading Markets
- Item 3.01 Notice of Delisting or Failure to Satisfy a Continued Listing Rule or Standard; Transfer of Listing
- Item 3.02 Unregistered Sales of Equity Securities
- Item 3.03 Material Modifications to Rights of Security Holders
Section 4—Matters Related to Accountants and Financial Statements
- Item 4.01 Changes in Registrant's Certifying Accountant
- Item 4.02 Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review
Section 5—Corporate Governance and Management
- Item 5.01 Changes in Control of Registrant
- Item 5.02 Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers
- Item 5.03 Amendments to Articles of Incorporation or Bylaws; Change in Fiscal Year
- Item 5.04 Temporary Suspension of Trading under Registrant's Employee Benefit Plans
- Item 5.05 Amendments to the Registrant's Code of Ethics, or Waiver of a Provision of the Code of Ethics
- Item 5.06 Changes in Shell Company Status
- Item 5.07 Submission of Matters to a Vote of Security Holders
Section 6—Asset-Backed Securities
- Item 6.01 ABS Informational and Computational Method
- Item 6.02 Change of Servicer or Trustee
- Item 6.03 Change in Credit Enhancement or Other External Support
- Item 6.04 Failure to Make a Required Distribution
- Item 6.05 Securities Act Updating Disclosure
Section 7—Regulation FD
- Item 7.01 Regulation FD Disclosure
Section 8—Other Events
- Item 8.01 Other Events
Section 9—Financial Statements and Exhibits
- Item 9.01 Financial Statements and Exhibits

If substantially the same information required for Form 8-K has been previously reported by the registrant in a filing with the SEC (such as in Part II of Form 10-Q or in a proxy statement), there is no need to include it on a Form 8-K.

If, within the four business days, a registrant issues a press release or other document that includes information meeting some or all of the requirements of Form 8-K, the information may be incorporated by reference to the document. The document incorporated by reference should be included as an exhibit to Form 8-K.

A few of the events and the required disclosures are discussed in more detail next.

(i) Item 2.01—Completion of Acquisition or Disposition of Assets

Disclosure is required of any acquisitions or dispositions of a significant amount of assets, other than in the ordinary course of business. Disclosures would include the transaction date, description of the assets, the purchase or sales price, the parties involved and any relationships between them, sources of funds used, and the use of assets acquired.

An acquisition or disposition is “significant” if:

For an acquisition or disposition of assets (versus a business), the net book value of the assets or the purchase price or sales price exceeds 10 percent of the registrant's consolidated assets before the transaction, or
The interest in the business bought or sold meets the test of a significant subsidiary at the 20 percent level.

Financial statements may be required to be filed for the acquired business, depending on its relative significance. The determination of significance is made by applying the significant subsidiary tests in comparing the latest annual financial statements of the acquired business to the registrant's latest annual consolidated financial statements filed at or before the acquisition (Rule 3-05 of Regulation S-X). The income and asset test should be as of the latest fiscal year; provided, however, that if the registrant has, since the end of the most recent fiscal year, consummated an acquisition for which historical and pro forma financial information has been filed on Form 8-K, then the pro forma amount in that Form 8-K for the latest fiscal year may be used. (Note: Registrants who believe their specific circumstances warrant the use of later financial information in other situations should consult with the Division of Corporation Finance, which will evaluate such requests on a case-by-case basis.)

If, based on such tests, none of the conditions exceeds 20 percent, financial statements are not required.
If any condition exceeds 20 percent, but none exceeds 40 percent, financial statements are required for the latest year prior to acquisition (audited) and for any interim periods required by Rules 3-01 and 3-02 of Regulation S-X (unaudited).
If any condition exceeds 40 percent but does not exceed 50 percent, financial statements are required for the two most recent years (audited), and for any interim periods (unaudited).
If any condition exceeds 50 percent, financial statements are required for the three latest years (audited), as required in Form 10-K, and for any interim periods (unaudited). However, only two years of financial statements are required if the acquired business revenues, in its most recent year, are less than $50 million or the registrant is a smaller reporting company.

If the acquired business or equity investee is a foreign entity, the entity's financial statements can be (1) presented in U.S. GAAP or (2) presented in IFRS as issued by the IASB or (3) presented in local GAAP if a reconciliation from local GAAP to U.S. GAAP is provided when the significance exceeds 30 percent.

Even if the reconciliation of U.S. GAAP does not need to be presented, reconciliation work will still be required with respect to the financial statements of foreign equity investees. This is because (1) the local GAAP financial statements of the foreign equity investees must still be converted to U.S. GAAP in order to properly apply the equity method of accounting and (2) Reg. S-X Rule 4-08(g) requires summary financial information regarding equity investees in accordance with U.S. GAAP in the notes to the primary financial statements.

Domestic issuers may now update the financial statements of acquired foreign businesses or foreign equity investees included in their filings on the same time schedule as foreign issuers. Regulation S-X governs the form and content of these financial statements. S-X schedules are not required.

If a portion of a business is being acquired, such as a division or a single product line, the registrant should provide audited financial statements only on the portion of the business acquired. Therefore, the registrant may, depending on the circumstances and with the permission of the SEC, present a “statement of assets acquired and liabilities assumed” (excluding amounts not included in the acquisition, such as intercompany advances) instead of a balance sheet and a “statement of revenues and direct expenses” for the business acquired instead of an income statement. A registrant, when acquiring a division or product line whose operations are included in the consolidated financial statements of a larger entity, should determine as soon as possible if the accountant reporting on the consolidated financial statements of the seller is able to report on the portion being acquired.

A significant acquisition or disposition under Item 2.01 will also require presentation of pro forma financial information giving effect to the event. The purpose of pro forma data is to provide investors with information about the continuing impact of a transaction and assist them in analyzing future prospects of the registrant. The main provisions of the rule (Regulation S-X, Article 11) are listed next.

The pro forma financial statements should consist of a condensed balance sheet as of the end of the most recent period and condensed income statements for the latest fiscal year and the interim period from the latest fiscal year-end to the date of the pro forma balance sheet. (Interim data for the corresponding period of the prior year is optional.)
Only the major captions of Article 5 of Regulation S-X need be presented. For the balance sheet, captions that amount to less than 10 percent of total assets may be combined; income statement captions less than 15 percent of average net income for the latest three years may likewise be combined.
The pro forma statements should be preceded by an introductory paragraph describing the transaction and should be accompanied by explanatory notes.
Ordinarily, the statements should be in columnar form, presenting historical statements, pro forma adjustments, and the pro forma totals. Care should be taken in combining pro forma adjustments to the same line item. Sufficient detail must be provided to allow for a clear understanding of the amount and nature of required adjustments. For a purchase business combination, the footnotes should tabularly indicate the components and allocation of the purchase price.
If the acquired business's fiscal year differs from that of the registrant by more than 93 days, the income statement of the acquired business for the latest year should be updated. This can be done by adding and deducting comparable interim periods. In that case, there should be disclosure of the periods combined and the revenues and income for periods excluded or for periods included more than once (e.g., an interim period included both as part of the fiscal year and subsequent interim period).
The pro forma income statement should end with income (loss) from continuing operations Material nonrecurring items and related tax effects that will affect net income within the next 12 months should be disclosed separately. Nonrecurring items included in the historical financial statements that are not directly attributable to the transaction should not be excluded from the pro forma financial statements.

If the assets acquired include assets relating to operations that the acquirer intends to dispose of, the Staff will not object to the presentation of those assets as a single line item in the pro forma balance sheet, provided the operations are not expected to be continued for more than a short period (i.e., 12 months) prior to disposal.

Adjustments to the pro forma income statement should assume that the transaction was consummated at the beginning of the earliest fiscal year and should include factually supportable adjustments that are directly attributable to the transaction and expected to have a continuing effect. Adjustments to the balance sheet should assume that the transaction had occurred at the balance sheet date and should include factually supportable adjustments that are directly attributable to the transaction (regardless of whether they have a continuing impact or are nonrecurring).

If an acquired entity was previously part of another entity, adjustments might be necessary when corporate overhead, interest, or income taxes had not been allocated by management on a reasonable basis. Similarly, if the acquired business was an S corporation or a partnership, adjustments should be made to reflect estimated officer salaries and income taxes. For dispositions, the adjustments should include deletion of the divested business and adjustments of expenses incurred on behalf of that business (e.g., advertising costs). For transactions accounted for as a purchase, the adjustments should reflect any the income statement of the purchase transaction (e.g., the impact of additional depreciation and amortization on the fair value of the acquired assets and interest on debt incurred to make the acquisition).

Tax effects of pro forma adjustments should be shown separately and ordinarily should be calculated at the statutory rate in effect during the periods presented.
In certain unusual instances, there may only be a limited number of clearly understandable adjustments, in which case a narrative description of the transaction may be substituted for the pro forma statements.
Historical and pro forma per share data, including the number of shares used in the computation, should be disclosed on the face of the pro forma income statement. If common shares are to be issued in the transaction, the per share data should be adjusted to reflect assumed issuance at the beginning of the period presented.
A financial forecast may be presented in lieu of the pro forma income statement. The forecast should be in the same detail as the pro forma income statements and should cover at least 12 months from the date of the most recent balance sheet included in the filing or the estimated consummation date of the transaction, whichever is later. Historical information for a recent 12-month period should be presented in a parallel column. The forecast should be presented in accordance with AICPA guidelines, with clear disclosure of underlying assumptions. Registrants rarely present a forecast in lieu of pro forma financial statements.

The determination of what constitutes a “business” for the purpose of determining whether financial statements are required to be included in the filing is a facts-and-circumstances test. This test would require an evaluation of whether there is sufficient continuity of the acquired entity's operations before and after the transaction so that presentation of prior financial data is meaningful for an understanding of future operations. There is a presumption that a subsidiary or division is a business, although a smaller component or an entity also could qualify. Among the matters to be considered are:

Whether the type of revenue-producing activity will remain generally the same
Whether physical facilities, employee base, marketing system, sales force, customer base, operating rights, production methods, or trade names will remain

Form 8-K provides for an automatic extension of up to a total of 75 days from the consummation of a business combination to file the historical audited financial statements and the pro forma financial information (a 71-day extension from the initial 4-day due date).

A registrant should provide all available information required under Items 2.01 and 9.01 for the business acquisition. The registrant may, at its option, include unaudited financial statements in the initial report on Form 8-K. No further extensions beyond the 71 days will be considered. The SEC has emphasized that the availability of the extension should not be an invitation for nontimely filing of the required information. Pro forma financial statements depicting a disposition are required to be included in the Item 2.01 Form 8-K filed within four business days of the disposition. The 71-day grace period does not apply to business dispositions.

(ii) Item 4.01—Changes in Registrant's Certifying Accountant

Certain disclosures are required in Form 8-K as a result of the resignation by (or declination to stand for reelection after completion of the current audit) or dismissal of a registrant's independent accountant or the engagement of a new accountant. Such changes in the accountant for a significant subsidiary on whom the principal accountant expressed reliance in his or her report would also be reportable events.

The Commission is concerned about changes in accountants and the potential for opinion shopping. Generally all 8-Ks reporting a change in accountant are reviewed by the Staff. When an independent accountant who was the principal accountant for the company or who audited a significant subsidiary and was expressly relied on by the principal accountant resigns (or declines to stand for reelection) or is dismissed, the registrant must make these four disclosures:

1. Whether the former accountant resigned, declined to stand for reelection, or was dismissed, including the date thereof and whether:

a. There was an adverse opinion, disclaimer of opinion, or qualification or modification of opinion as to uncertainty, audit scope, or accounting principles issued by such accountant for either of the two most recent years, including a description of the nature of the opinion.

b. The decision to change accountants was recommended by or approved by the audit committee or a similar committee or by the board of directors in the absence of such special committee.

2. Whether during the two most recent fiscal years and any subsequent interim period preceding the resignation, declination, or dismissal there were any disagreements with the former accountant on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreement(s), if not resolved to the satisfaction of the former accountant, would have caused the accountant to make reference to the subject matter of the disagreement(s) in connection with his or her report. If such disagreement occurred, the registrant must disclose:

a. The nature of the disagreement

b. Whether any audit committees (or similar body) or board of directors discussed the subject matter of the disagreement with the former accountant

c. Whether the registrant has authorized the former accountant to respond fully to the successor accountant concerning the matter

The term disagreements should be interpreted broadly but should not include preliminary differences of opinion that are “based on incomplete facts” if the differences are resolved by obtaining more complete factual information.

3. Whether there were any “reportable events” during the two most recent fiscal years or any subsequent interim period preceding the resignation, declination, or dismissal, including:

a. The auditor having advised the registrant that the internal controls necessary to develop reliable financial statements do not exist

b. The auditor having advised the registrant that information has come to the auditor's attention that led him or her to no longer be able to rely on management's representations or that has made him or her unwilling to be associated with the financial statements

c. The auditor having advised the registrant that there is a need to significantly expand the audit scope or that information has come to the auditor's attention during the last two fiscal years and any subsequent interim period that, if further investigated, may (1) materially impact the fairness or reliability of either a previously issued audit report or the underlying financial statements or the financial statements issued or to be issued for a subsequent period or (2) cause the auditor to be unwilling to rely on management's representations or to be associated with the financial statements and due to the change in auditors, the auditor did not expand his scope or conduct a further investigation

d. The auditor having advised the registrant that information has come to the auditor's attention that he or she has concluded materially impacts the fairness or reliability of either (1) a previously issued audit report or the underlying financial statements or (2) the financial statements relating to a subsequent period and, unless the matter is resolved to the auditor's satisfaction, the auditor would be prevented from rendering an unqualified report and, due to the change in auditors, the matter has not been resolved

4. When a new independent accountant has been engaged, the registrant must identify the newly engaged accountant and the date of the engagement. In addition, if, during the two most recent fiscal years or subsequent interim period, the registrant or someone on its behalf consulted the newly engaged accountant regarding the application of accounting principles as to any specific transaction, either completed or proposed, the type of audit opinion that would be rendered on the registrant's financial statements, or any matter of disagreement or a reportable event with the former accountant. If such a consultation took place, the Form 8-K must:

a. Describe the accounting issue and the newly engaged accountant's view. Any written opinion issued by the new accountant must be filed as an exhibit, and the new accountant must be provided the opportunity to review the disclosure and furnish a letter to the SEC that clarifies or expresses disagreement with the registrant's disclosure of its views.

b. State whether the former accountant was consulted regarding such issues and, if so, describe the former accountant's views.

Disagreements and reportable events are intended to be communicated to the registrant orally and in writing. Because these are sensitive areas that may impugn the integrity of management, communication will have to be handled with extreme care on the part of all involved.

The auditor who is aware that a required filing related to a change of accountants has not been made by the registrant should consider advising the registrant in writing of that reporting responsibility with a copy to the Commission.

The PCAOB adopted as part of its interim standards a rule of the Center for Public Company Audit Firms of the AICPA (successor to the Securities and Exchange Commission Practice Section (SECPS)), which also requires the auditor to provide written notification, within five business days, that the auditor has resigned, has decided not to stand for reelection, or has been dismissed. The purpose of this “five-day” letter is to provide early notification to the SEC in advance of the Form 8-K filing due date. This letter is addressed to the client, with a copy to the SEC (generally faxed), and states simply that the relationship has been terminated.

Additionally, Item 304 of Regulation S-K requires the registrant to disclose similar information about auditor changes during the two years preceding the filing of registration statements for initial public offerings.

(iii) Item 4.02—Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review

Item 4.02 requires a company to provide certain disclosures when a company's previously issued financial statements should no longer be relied on because of an error (as addressed in ASC 250 (SFAS No. 154, Accounting Changes and Error Corrections)). The disclosures must be made whether the company (Item 4.02a) or its independent auditors (Item 4.02b) make this determination. In either case, the company must disclose:

1. The date of the determination and identification of the financial statements and years or periods covered that should no longer be relied on

2. A statement that the audit report should no longer be relied on

3. A brief description of the facts underlying the determination to the extent known to the company at the time of filing

4. A statement as to whether the audit committee, the full board if there is no audit committee, or an authorized officer has discussed the matter giving rise to the determination with the company's independent accountant

If the company's independent accountant makes the determination, the company must provide the accountant with a copy of the disclosures it is making under this item no later than the day it files the Form 8-K. The company must also ask the accountant to furnish as promptly as possible a letter addressed to the SEC, stating whether the accountant agrees with the company's disclosure and if not, why not. The company must then amend the Form 8-K to file the accountant's letter as an exhibit within two business days of receipt of the letter.

If the registrant determines that its previously issued financial statements can no longer be relied on because of errors or its auditor advises that the previously issued audit report or completed interim review should no longer be relied on, the company must file a Form 8-K within four business days. If the registrant determines that an error and an associated restatement are not material (and that a Form 8-K filing is therefore not necessary), the Staff advises that the company should be prepared to support its conclusion. Also, the Staff may question the timing of the Form 8-K if it is filed shortly before an amended Form 10-K or 10-Q filing. Given the time it usually takes to prepare restated financial statements, this suggests that the Form 8-K may not have been filed within four business days of the date the registrant concluded the financial statement should not be relied on. The Staff observe that registrants are always required to file Item 4.02 Form 8-Ks when prior financial statement should not be relied on and that it is not appropriate to disclose this information in quarterly or annual reports.

5.7 Proxy Statements

(a) Overview

Because of the geographic dispersion of the owners of a public company, it is unlikely that a quorum could be obtained at any meeting that required a vote of the shareholders. As a result, the use of proxies and proxy statements developed to facilitate such votes. A proxy is broadly defined as any authorization given to someone by security holders to act on their behalf at a stockholders' meeting. The term proxy also refers to the document used to evidence such authorization. Persons soliciting proxies must comply with Regulation 14A and the 1934 Act, which prescribes the content of documents to be distributed to stockholders before, or at the same time as, such solicitation occurs.

The informational content of the proxy statement provided to the stockholders depends on the action to be taken by the stockholders. Schedule 14A prescribes the informational content required based on the specific circumstances.

When the vote is solicited for (1) an exchange of one security for another, (2) mergers or consolidations, or (3) transfers of assets, the transaction constitutes an “offer to sell securities.” As such, a registration statement is required under the 1933 Act and can be filed on Form S-4 (Form F-4 for foreign private issuers in similar transactions).

(b) Regulation 14A

The SEC derives its authority to regulate the solicitation of proxies from the Exchange Act and from the Investment Company Act of 1940. Section 14(a) of the Exchange Act states:

It shall be unlawful for any person, by the use of the mails or by any means or instrumentality of interstate commerce or of any facility of a national securities exchange or otherwise, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors, to solicit or to permit the use of his name to solicit any proxy or consent or authorization in respect of any security (other than an exempted security) registered pursuant to Section 12 of this title.

Based on this statutory authority, the SEC established Regulation 14A to regulate proxy solicitations. Regulation 14A consists of these rules:

14a-1	Definitions
14a-2	Solicitations to Which Rules 14a-3–14a-15 Apply
14a-3	Information to Be Furnished to Security Holders
14a-4	Requirements as to Proxy
14a-5	Presentation of Information in Proxy Statements
14a-6	Filing Requirements
14a-7	Obligation of Registrants to Provide a List of, or Mail Solicitation Materials to, Security Holders
14a-8	Shareholder Proposals
14a-9	False or Misleading Statements
14a-10	Prohibition of Certain Solicitations
14a-11	Shareholder Nominations
14a-12	Solicitation Before Furnishing a Proxy Statement
14a-13	Obligation of Registrants in Communicating with Beneficial Owners
14a-14	Modified or Superseded Documents
14a-15	Differential and Contingent Compensation in Connection with Roll-up Transactions
14a-16	Internet Availability of Proxy Materials
14a-17	Electronic Shareholder Forums
14a-18	Disclosure Regarding Nominating Shareholders and
	Nominees Submitted Pursuant to Applicable State of Foreign Law, or a Registrant's Governing Documents
14a-20	Shareholder Approval of Executive Compensation of TARP Recipients

Because of the complexity of these rules, most are not discussed in detail here. However, it is important to remember that proxies and proxy statements are different from other SEC filings because they are required to be sent directly to the security holders. Registration statements are filed directly with the SEC. Annual reports on Form 10-K are filed with the SEC and are furnished to the shareholder only on request. Typically, the proxy materials must be given to the shareholders at least 20 days prior to the meeting date. Companies listed on the NYSE provide shareholders 30 days to review the materials.

The proxy rules require companies to provide shareholders with proxy cards to give them more opportunity to participate in corporate elections. Shareholder proxy cards must (1) indicate whether the proxy is solicited on behalf of the board of directors, (2) enable shareholders to abstain from voting on directors and other proxy matters as well as to approve or disapprove each matter, and (3) allow shareholders to vote for or withhold authority to vote for each nominee for the board of directors. Registrants may provide their proxy materials on the Internet and provide shareholders with a notice of Internet availability of proxy materials instead of mailing a hard copy of the materials to each shareholder. Shareholders can request and the registrant must provide paper copies of the materials.

(c) SEC Review Requirements

Except as noted in this section, Rule 14a-6 requires that preliminary copies of the proxy statements and related materials be filed with the SEC at least 10 calendar days prior to the date definitive copies of such material are first sent or given to security holders. Such materials should be appropriately marked as “Preliminary Copies,” and the date definitive materials are to be mailed to the shareholders must be stated in the filing. Earlier submission (usually more than 20 days) is advisable to allow time for any changes that may be required as a result of the SEC's selective review process.

Preliminary proxy materials need not be filed with the Commission if the solicitation relates to any meeting of security holders at which the only matters to be acted on include these six:

1. The election of directors

2. The election, approval, or ratification of accountant(s)

3. A shareholder proposal

4. With respect to a registered investment company or business development company, a proposal to continue, without change, any advisory or other contract or agreement that has been the subject of a proxy solicitation for which proxy material has previously been filed

5. With respect to an open-end registered investment company, a proposal to increase the number of shares authorized to be issued

6. The approval or ratification of certain compensation plans (i.e., restricted stock, SARs, or stock options) or amendments to such plans. This exemption does not, however, extend to the approval of awards made pursuant to such plans.

Information in preliminary proxy material will be made available to people requesting it after the definitive proxy is filed, unless an application for confidential treatment for such information is made at the time of filing the preliminary proxy material and approved by the SEC. Such preliminary material will also be made available to people requesting it if no definitive filing is anticipated.

Before the registrant files the preliminary material, the accountant should read the entire text and compare it with the financial statements. This procedure is intended to avoid inconsistencies and misleading comments of which the accountant may have knowledge and to ascertain that the financial statements include disclosures mentioned in the text that are appropriate for a fair presentation of the financial statements in conformity with GAAP.

If the audit has not been completed, the SEC requires that a letter from the independent accountant accompany the preliminary material. The letter should state that the accountant has considered the preliminary material and will allow the use of his or her report on the financial statements. This letter is addressed to the registrant, who, in turn, submits it to the SEC. When preparing the letter, the accountant should avoid using general terms such as “considered” or “reviewed” in describing the work and should avoid expressing approval, either directly or indirectly, of the sufficiency of disclosures in the text. The accountant should state that he or she has read the preliminary proxy statements and will upon completion of the audit allow use of the report on the financial statements. The financial statements covered by the report, and the date of the report, should be specified in the letter. When a proxy statement is prepared for a proposed merger, the letter should relate only to the company with which the accountant is familiar.

Copies of the definitive material that are mailed to stockholders should be filed with the SEC no later than the date such material is mailed to the stockholders.

If changed circumstances or new events arising between the time the proxy solicitation is mailed and the stockholders' meeting date cause the proxy material to be materially false and misleading, the corrected material should be disseminated promptly to the stockholders and to the SEC (with markings clearly indicating the changes).

¹ J.L.Wiesen. Regulating Transactions in Securities (St. Paul, MN: West Publishing Co.: 1975).

² Note that Item 4 is currently reserved for future use.

³ Item 4 is reserved for future use.

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Table of Contents for Chapter 5: Securities and Exchange Commission Reporting Requirements

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5.1 Securities and Exchange Commission

(a) Creation of the Securities and Exchange Commission