Do Your SEC Filings Paint the Appropriate Picture of the Company?

SEC Painting a Picture of Your BusinessDuring the recently completed filing season for calendar year-end Smaller Reporting Companies I frequently provide suggestions for improving the overall quality of the Form 10-K.  This generally includes suggestions to eliminate redundancy; provide concise and specific disclosures; provide useful analysis of historical results; and provide reasonable expectations related to future near term trends, commitments, liquidity, and other known material events and transactions.   These suggestions not only affect the financial statements, but they generally apply to other significant areas such as business overview, risk factors, and management’s discussion and analysis.

In my experience, issuers tend to rely on their attorneys for guidance on the non-financial statement portions of the Form 10-K.  Most attorneys that I have dealt with focus only on standard regulation compliance and lawsuit prevention.   While these things are obviously important, they generally do not improve the quality of the disclosures.  To be fair, most attorneys are not asked to help make improvements in order for issuers to somewhat manage attorney fees.

The SEC’s Corp Fin Staff recently published Staff Observations in the Review of Smaller Reporting Company IPOs at which provides a brief reminder for quality improvement and avoiding the comment process.  While these observations specifically relate to registration statements they are also applicable to Forms 10-Q and 10-K.

Some highlights:
Risk Factors – “Generic risk factor discussions that do not describe how a specific risk applies to the company or an investment are not helpful to understanding the risk.  Also, it is rarely helpful to state there can be no assurance of a particular outcome”

Description of Business – Reg. S-K requires a description of a company’s business development over the last three years and provides an overview of the material aspects of the business.  Further, “Where it was not clear what a company did to generate revenue or what its future growth strategy was, we (Corp Fin Staff) asked it to provide a discussion of its current or intended material sources of revenue”.  My experience is that several issuers focus on historical reverse merger and similar capitalization transactions while ignoring the current and near term future functional activities.

Management’s Discussion & Analysis – Financial based discussion should focus on “Any known material trends, demands, commitments, events, or uncertainties that will have, or are reasonable likely to have, a material impact on the company’s financial condition; short-term or long-term liquidity; and revenue or income from continuing operations”.  They further state this section should disclose “The past and future financial condition and results of operations of the company, with particular emphasis on the prospects of the future”.  I don’t believe that providing a narrative of the financial statements, by itself, meets the requirements of Item 303 of Reg S-K or provide any additional useful information.  The SEC’s observations indicate results of operations should “Disclose the reasons underlying the causes for the period to period changes”.

Financial Statements; Revenue Recognition – The SEC observations generally recommend an issuer’s revenue recognition policy discloses the “application of specific authoritative revenue recognition guidance for transactions within the scope of the appropriate GAAP literature; the nature and type of earned revenue; and separate revenue recognition policies for each type of earned revenue”.  I don’t think cutting and pasting the SAB 104 requirements or GAAP literature on its own meets these observations.
I realize compliance document improvement is probably not on the top of most Smaller Reporting Company’s priority list in today’s environment, but there is definite value in avoiding the SEC comment process.  Also, a Smaller Reporting Company’s SEC filings, to a certain extent, serve as the public face of the company and should reflect the high degree of professionalism the boards, officers, and employees of these companies possess.

IFRS – No Big Deal!

Judging by the material that is coming out from the Big 4 accounting firms, it seems that accounting as we know it is about to disappear and a new behemoth called IFRSs are about to invade the US accounting scene.  Recently the office managing partner of one of those firms admitted to me that they viewed the issue as a consulting opportunity rather than a threat.  I agree.

Judging by the material that is coming out from the Big 4 accounting firms, it seems that accounting as we know it is about to disappear and a new behemoth called IFRSs are about to invade the US accounting scene.  Recently the office managing partner of one of those firms admitted to me that they viewed the issue as a consulting opportunity rather than a threat.  I agree.  Fear mongering is a great way to generate revenue for the consultants.  Just look at the millennium bug.

IFRS are already here and have been for quite some time. Most of the standards that have been issued since in the past four years have been designed to bring US GAAP standards and international GAAP standards (IFRS) closer and closer together.  This is commonly referred to as ‘convergence’.   FASB 141 (R) for business combination’s and FASB 160 on minority interests are typical examples. FASB has issued  standards that are  consistent with the international standards.  The International Accounting Standards Board (IASB) is doing the same thing as the FASB. They are issuing standards to bring them closer to US GAAP alternative over time where US GAAP is deemed preferable to IFRS. This convergence process has been going on for years and is nothing new.

What is new is the “road map” that has been put in place by the SEC, and it changed again recently. Foreign listers on the US exchanges are already allowed by the SEC to use IFRS. A limited group of about 100 US companies will experiment with early adoption of IFRS in the US in 2009. Most of these companies are already using IFRS for significant parts of their international operations anyway so they don’t need much outside help. For the rest of us, the SEC will make a decision in 2011 on whether to move to require all US listed companies to follow IFRS by 2014. Unless we get some xenophobic idiots appointed to the SEC  this is a done deal.  Although the new SEC Chairperson, Mary Shapiro, has announced that she is considering slowing down the process, it probably won’t change the FASBs agenda.

Is this a major issue? I don’t think so. By 2014, all of the major differences between US GAAP and IFRS will almost certainly have been eliminated. There are some problem issues to be resolved. Some are straightforward like the use of LIFO for inventory accounting. The problem here is that tax accounting in the US is impinging on real accounting. We will have to find some tax solution to unbundle the inbuilt tax problem that LIFO has created for many companies.

Other issues are more difficult and highly technical. The ugly issue of derivatives is always at the forefront here. Almost nobody understands the US standard FASB 133 and the same is true that almost nobody understands its international equivalent. All we know is that they have some differences and the financial institutions don’t like either of the standards anyway.

Some issues appear more frightening. For example, with IFRS we will lose those “bright line” guidelines that US accountants love so much. For example, the four tests for a capital lease that lawyers love to circumvent will be no more. Greater judgment will be required. This is an issue because you may have to get up in a court of law to defend your judgment. Looking on the bright side, at least you wont get tripped up by some smart trial lawyer because you did not follow some little known paragraph of one of the 14 FASs, 6 INTs, 10TBs, 2FASBSPs and about 25 EITFs that currently relate to leases in US GAAP. They will be gone as authoritative documents.

For non-listed companies, there are some proposals on the table on how to apply IFRS to smaller entities. Personally I don’t like the proposals because I don’t like having two-tier GAAP for large and small enterprises. Again, whatever changes occur will drift in over time largely unnoticed by most.  If you have any experience with IFRS please comment.

How to create profits out of thin air

In my last posting I tried to make assets out of liabilities.  Now I want to make some profits out of my liabilities.  This is a piece of cake under current GAAP but my current favorite again relates to the issue of the convertible debt that seems to be so popular with companies with a bit of a going concern problem. Continue reading “How to create profits out of thin air”