Governance – Excelsis Accounting Group

MD & A Are You Blowing an Opportunity?

As a service to our public company clients we routinely perform an extensive review of the other information included in their annual report. While completing a large number of such reviews recently for our clients with December 31 year-ends we became aware of opportunities that are regularly over-looked by issuers. In preparing Management’s Discussion and Analysis there are some critical elements that will make them more effective.

Attitude – your MD & A is an opportunity to tell the story of the company in a positive way. As is your web page, your SEC filings are the ‘face’ of the company to potential shareholders, investors and others considering doing business with you. Do not minimize this opportunity by viewing it primarily as an obligation. We all have a tendency to spend less time on things we view as ‘necessary evils’ as opposed to ‘opportunities’.

Approach – the primary purpose of the MD & A is to allow the reader to “look at the company through the eyes of management by providing both a short and long-term analysis of the business of the company” (SEC Financial Reporting Policies sec. 501). The MD & A is intended to be entirely prospective, not historical. Too frequently we see comments like “As of 12/31/x1 revenues declined $xxx,xxx which was a reduction of x% over revenues of $xxx,xxx as of 12/31/x0”. That’s historical, not prospective, and anyone could calculate it from the financials. It provides no additional information of any value to the reader.

Executive Level Overview – Sec. 501.12 is a gift from the SEC that most issuers don’t open. This is a chance to tell your story. Because many companies have become larger, global and more complex, and the disclosure rules correspondingly so, MD & A has become lengthy and complex and correspondingly, boring and so not read as thoroughly as it should be. In an effort to improve clarity and understandability many company’s are incorporating an Executive Level Overview (ELO) as an introductory section summarizing the most significant areas of the MD & A that management wants to emphasize. Typically this includes: economic or industry wide factors; how the company earns revenues and generates cash; lines of business, locations, principle products, services; and provide insight into material opportunities, challenges and risks which management is most focused on.

It is a ‘highlight’ of those things that are important to the company, reported elsewhere as well (e.g. Risk Factors, or Business Description).

Liquidity, Capital Resources, Results of Operations – You must address each of these areas specifically. When drafting these comments keep in mind that you should address three questions for the reader: (1) What happened? (2) Why did it happen? and most importantly (3) Is it expected to continue? That last one is the crux of the MD & A. Remember – the reader is entitled to assume that “past performance is indicative of future performance” unless you tell him different.

Other Tips – (1) If you’ve previously discussed it in your Form 10k you don’t need to keep beating it to death unless it applies to new information in the current interim filing . Most companies over disclose information that they’ve previously discussed numerous times. The unwelcome result is that the points you want to make get buried in the irrelevant. (2) Discussion for interim reports should be limited to material changes occurring subsequent to the last annual report. Over disclosure, again, can result in burying relevant information in the minutiae. (3) The SEC requires that it be “presented in clear and understandable language”. That means you need to lose the ‘legalese’. (4) In the words of an internationally recognized securities attorney with whom we’ve worked – “Disclosure is too important to leave up to only the attorneys”. While their focus is compliance, as it should be, this is more than a compliance document. It is the public face of your company. Remember it is an opportunity to ‘sell’ to investors, financiers and those people you want to do business with. (5) Finally, sentence structure, grammar and spelling are critical. If your MD & A is sloppy, those reading it will assume the company is run the same way.

You have a great company with a great business plan and outlook for the future. Tell the world in your MD & A.

IFRS – Time to Panic?

IFRS is a ticking time bomb! In recent months the focus of discussions related to adoption of the International Financial Reporting Standards have centered on differences with US GAAP (such as LIFO inventory), timing and implementation. I don’t want to debate the necessity of adopting a world standard given our weakening influence over the world economy, or the esoteric benefits or detriments. My concerns are much more basic. Without tort reform in the United States, IFRS is a time bomb with a very short fuse resulting in a cataclysmic disaster waiting to happen.

Currently, US GAAP is a rules based set of standards. While the end result of their application frequently results in worthless unsupportable financial reporting, the issuer and their auditor have but to point to the ‘rules’ in defense. On the other hand, IFRS is principles based, and simpler to apply. But it can and frequently does require the issuer and his auditor to exercise judgment. Judgment that can be questioned, criticized and litigated.

Please don’t misunderstand. Professionally in my opinion the quality of financial reporting will be significantly improved by the application of sound principles. IFRS is long overdue. Without liability reform, however, I fear financial reporting and assurance services will quickly follow the health care industry in terms of cost to the providers.

Maybe I’m just paranoid in my advancing years.

Oil and Gas Accounting – SEC Issues SAB 113

Oil & Gas Industry The Office of the Chief Accountant through Corp Fin recently published Staff Accounting Bulletin 113. There are four main areas of focus within this SAB which will likely affect everyone to some degree: valuation methodology of oil and gas reserves; clarification of methodology related to write-offs of excess capitalized costs under the full cost method; extending appliability of guidance to include unconventional methods of extracting oil and gas from sand and shale; and removing information from the guidance which is no longer necessary.

For the most part SAB 113 is pretty straight forward, however, as is the case with many of the SABs, hidden in the minutiae are land mines for the unwary or uninformed. Correspondingly you would be well served to skim through it for any matters that might affect your company, and then discuss them with your audit firm.

Additionally, on October 26, 2009 additional Oil and Gas Rules were released. These compliance and disclosure interpretations (C & DIs) relate to Regs S-X and S-K. There is some important information here which is very relevant and brief!

Hip Hip Hooray! Permanent exemption from 404(b) for Small Business is Possible!

Permanent Exemption Possible Recently, the House Financial Services Committee passed H.R. 3817, the Investor Protection Act. The bill includes an amendment, which would permanently exempt small public companies from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. The bill must still be voted on by the entire House of Representatives, but it is nice to know that there is hope.

As noted in the October 19^th blog post by Mark Bailey, the 404(b) requirement for small business issuers is not beneficial in most cases and thus the passing of this act by the House Financial Services Committee is welcome news.

SOX 404(b) – The Tar Baby and the SEC

Br'er Rabbit and Tar-Baby As a youngster the Song of the South stories penned by Joel Chandler Harris at the beginning of the 20th century and brought to life by Disney were some of my favorites. In one, Bre’r Fox and Bre’r Bear make a tar baby to catch Bre’r Rabbit. Bre’r Rabbit becomes offended when the inanimate tar baby doesn’t respond, strikes it and becomes stuck to it. The more he struggles the more inextricably attached he becomes. It certainly seems that the SEC has found a tar baby in SOX 404(b) as it pertains to non-accelerated filers.

Recently the SEC deferred the compliance date – once again. This time for 9 months. The reason for further deferral was explained as being necessary as the results of an on-line survey conducted by the SEC which was not completed in time. A survey, I venture, that was essentially unknown to virtually everyone it might have affected, so not having it available was irrelevant.

As you may recall the original rationalization for 404 included the premise it would reduce fraud while increasing investor confidence in the issuer’s reporting. Those interviewed for the survey above indicated they did not believe there had been any increase in investor confidence as a result of 404 applied by large filers. Yet in his public comment, Commissioner Aguilar stated ” I join Chairman Shapiro in assuring investors that there will be no further extensions of the compliance deadline.” What am I missing? By the SEC’s own survey, investors don’t care! So why is it mandated? Certainly there can and have been benefits enjoyed by larger issuers. For them it is good governance in many cases, and worthwhile. But not for small companies.

There is essentially no benefit to most non-accelerated filers either actual or perceived in most cases, and the cost is proportionately greater than for larger companies. Both the SEC and the PCAOB have exercised common sense in promoting ‘scalability’ in other areas. They need to do so here as well by eliminating the requirement – one with no or negligible benefit and grossly disproportionate cost – for small non-accelerated issuers.

Will it reduce fraud in small companies? I seriously doubt it and I believe most public company audit partners would agree. The SEC has the weapon it needs to fight fraud in the 302 certifications.

Send this tar baby back to Congress and let the money be redirected for innovation and growth.

Risky Business for Directors – How's your ERM?

Risky Business for Directors Not so many years ago, being elected to the Board of Directors of some companies essentially required you to act as a figurehead. Lunch in an expensive restaurant once a month, an annual retreat to a vacation resort to discuss corporate ‘strategy’ and a small stipend were all that was required in trade for the collective experience and informal leadership. That’s all changed with the increased exposure to liability now faced by corporate governance. With the current state of our business environment, that exposure is greater this year than ever.

In an on-line article Executives Anticipate Rise in Fraud nearly two thirds of the executives polled anticipate an increase in fraud and misappropriation this year. In conjunction with auditors anticipating that nearly 25% of all firms may not be going concerns; the myriad of new regulatory requirements related to governance; and the corporate challenges fomented by a floundering economy this may not be a desirable year to be a Director. The current hot topic seems to be enterprise risk management.

While a long time focus of management, ERM has often been given little attention by the board. Recently, COSO published a document highlighting four critical areas that contribute to effective board oversight. It can be downloaded at www.coso.org.

As public company auditors and consultants we have observed the importance of an integrated approach to governance between the board and management. We regularly participate in joint meetings as frequently as allowed (we don’t charge for meetings with management and the board), for our own self-interest. Our best clients have the strongest most engaged boards. Boards of Directors are invaluable resources. Take full advantage.

E & Y Calls for More Regulation (More Cost)

In a speech at the Commonwealth Club in San Francisco recently, EY CEO James Turley called for more regulation of audit firms. His premise that audit quality has improved as a result of SOX and the PCAOB while ‘possibly’ accurate (and I’m not conceding that) is irrelevant. Foremost I don’t believe that quality has improved for quality firms. I can’t speak for EY. Perhaps they are better for it. The SEC and the PCAOB for all intents and purposes initially adopted the accounting and internal control standards that were already promulgated by the profession. Adding another layer of regulation sufficed only in adding additional cost to public companies. And now Mr. Turley wants to expand that further. Why?

Since my introduction to the profession in the 1970’s when we were attacked by Michigan Democratic Congressman John Dingell, we have fought for self regulation. Obviously the SEC Practice Section of the AICPA (the forerunner to the Center for Audit Quality CAQ) failed miserably and here we are. Based on his leadership, it appears the CAQ is on the same course. One of the defining characteristics of any profession is self regulation. So we apparently have failed as a profession if you are to subscribe to Mr. Turley’s pleading or does he have another motive?

Economists define this propensity of larger firms ‘getting cozy’ with regulators in order to drive up costs and limit competition from smaller firms as ‘regulatory capture’. Banks, drug companies, airlines – accounting firms? Bigger isn’t better, but it certainly seems to be more expensive.

From my days as a young corporate bank officer for a mid-sized California bank in the early 1970’s, I recall having regulatory audits by Federal regulators, the State of California examiners, and the Federal Depositors Insurance Corporation (FDIC). We also had our own internal audit department as did every other bank. And as every other bank has had since then. Total regulation. It’s obviously worked well Mr. Turley. In my professional lifetime a list of the most heavily regulated industries would include banks, airlines, railroads, banks, banks, banks. More regulation. Yeah! That’s the answer.

More recently we have two great examples of failures by federal regulation in Madoff and Stanford. I challenge you to name one economy with more regulation than we have had in the US that has been more successful. Ever. I can list dozens that failed with more regulation.

I disagree vehemently with Jim Turley. Additional regulation if warranted should come from inside the profession – specifically the CAQ which Mr. Turley happens to be the sitting Chair of. Do the job you signed on for with the CAQ Mr Turley. That he wants to abdicate that responsibility is incredibly disturbing. That he proposes to add additonal layers of cost – cost that he and his firm will derive revenue directly from- is unconscionable.