The SEC's Annual Report to Congress

By William J. Coffey, Gary Illiano, and Lewis Schier

The 1994 annual report contains a wealth of information on the activities of the SEC. The authors concentrate on the Division of Corporate Finance, the Office of the Chief Accountant, and the Enforcement Division.

Last year marked the 60th anniversary of the SEC. The SEC's 1994 Annual Report to Congress contains a plethora of information on the activities of the commission for the fiscal year ended September 30, 1994. It is available for $6.50 at any U.S. Government Printing Office Bookstore. Wondering what issues Corporation Finance targeted for reviews? Curious about how many cases were brought by the Division of Enforcement alleging misconduct by accountants? Need to know in which cities the SEC maintains reference facilities open to the public? It's all there, in an easy-to-find format.

The annual report is divided into 11 sections. It begins with introductory material on the commission, the staff, and the five regional and six district offices. Need to know the name of the chairman? Arthur Levitt's biography begins on page xi. Wondering which regional office would handle an SB-2 filing for your client based in Virginia? The Northeast office, according to the map on page xv.

Next come nine sections that report on the various divisions and offices: enforcement, international affairs, market regulation, investment management, corporation finance, Chief Accountant, General Counsel, economic analysis, and a section on policy management and administrative support. For example, the subsection on administrative support describes the activities of the public reference rooms in the Washington, D.C., New York, and Chicago offices.

An appendix filled with tables, graphs, and charts rounds out the report. Need a copy of the SEC organizational chart? It's on the last page, 161. Wondering whether the SEC drains or contributes to the U.S. Treasury? Table 24 shows that for the twelfth consecutive year, the SEC has been a net contributor, providing over $300 million to the Treasury in 1994. Total fees exceeded $580 million, over 200% of the SEC's appropriated spending authority.

Three operating departments covered in the annual report may be of particular interest to accountants: the Division of Corporation Finance (Corp Fin), the Office of the Chief Accountant, and the Division of Enforcement.

Corporation Finance

Generally, accountants will have more occasion to deal with the Division of Corporation Finance than the other divisions of the commission. The full disclosure system, administered by Corp Fin, provides staff review of registration statements and periodic reports filed by registrants. The resulting letters of comment sent to issuers may include guidance as to financial accounting and reporting. Ordinarily, a registrant's independent accountants will be consulted in formulating the proper response to the staff's accounting comments.

Registration Activity. The 1994 report provides dollar value pie-chart comparisons with 1993 of registration statements filed with the commission. The two charts, which show debt, equity, asset backed, and shelf registrations for both years, reveal some interesting trends. Even though total registrations were down slightly, a definite shift from debt to equity financings took place in 1994. A total of nearly $815 billion was registered in 1994 compared with a record high of $868 billion in 1993. Common stock offerings reached a new high in 1994, with $330 billion filed; this included more than $82 billion for initial public offerings.

As a percentage of the total amount registered, common stock rose to 41% from 32% in 1993. Asset-backed securities offerings were $179 billion, or 22% of the total, up from $126 billion in 1993, or 15% of the total. Shelf offerings were up slightly, but the most dramatic change was in the amount of debt securities offered, which dropped in 1994 to $194 billion (24%) from $374 billion (43%) in 1993.

Staff Review. Compared to 1993, the staff reviewed more filings by new issuers, but the number of reporting issuer reviews dropped slightly. New issuer reviews, where nonreporting companies filed a Securities Act or Exchange Act registration statement during the year, increased 33% to 1,599 from 1,200 in 1993. Reporting issuer reviews, which consist of the review of any combination of, among others, annual reports, quarterly reports, proxies, and Securities Act registrations, dipped four percent to 3,400 from 3,531.

Corp Fin targeted for review derivative securities and restructuring charges. With a number of public companies reporting losses from derivative securities transactions, the staff reviewed 500 filings for adequacy of disclosure of the type, extent, and potential effects of derivative activities. Where disclosure was inadequate, letters of comment requesting improved derivatives disclosure were sent to registrants. Given the October 1994 release of SFAS No. 119, Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments, we expect the staff to continue monitoring this area.

Corp Fin targeted corporate restructurings due to the dramatic increase in these transactions. The staff sent letters to companies that announced such charges to remind them of proper disclosure, and subsequently reviewed the filings of several hundred companies. In January 1995, the SEC staff announced its plans to interpret literally the provisions of Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).

International Initiatives. In 1994 there was a dramatic increase in the number of foreign companies participating in the U.S. public markets, with 138 companies from 17 countries filing here for the first time. Total registered public offerings by foreign issuers during 1994 reached $36 billion, and at year-end, over 635 foreign companies were filing reports with the SEC.

Perhaps one reason 1994 showed a dramatic increase in foreign company participation is that the commission adopted several amendments to its rules and regulations to simplify reporting and registration for foreign private issuers.

Some amendments benefitted both domestic and foreign issuers. For example, many of the financial schedules required in annual reports and registration statements have been eliminated. These include separate schedules for marketable securities, certain receivables, related party indebtedness, property plant and equipment, accumulated depreciation, guarantees of securities, short-term borrowings, and supplementary income statement information.

Other amendments simply leveled the playing field for foreign issuers. For the first time, the commission made available short-form (F-3) and shelf registration (delayed offerings) for foreign issuers to the same extent available to domestic issuers. Changes include shortening the minimum reporting period to 12 from 36 months, reducing the public float requirement to $75 million from $300 million, and allowing registration of different types of securities on a single shelf registration statement without specifying the amount of each class offered. Similar changes were made to the multijurisdictional disclosure system for the benefit of Canadian issuers.

In line with the SEC's active involvement with the International Accounting Standards Committee (IASC) in international standard setting, foreign companies also may use international accounting standards (IASs) for selected items such as the statement of cash flows (IAS No. 7), business combinations (IAS No. 22), and reporting the effects of changes in foreign currency rates (IAS No. 21). This means certain reconciliations to U.S. GAAP are no longer required if the disclosure conforms to the applicable international standard.

Included, among others, are amendments that permit foreign private issuers more time to update their financial statements and allow domestic companies more latitude in providing financial statements of significant foreign equity investees and acquired businesses.

Forward Looking Information. Lately, a concern in Congress as well as at the SEC is the issue of liability for "forward looking" information. Included in the debate are concerns about forecasts and projections, management discussion and analysis (MD&A) disclosure, and estimates used in preparing financial statements. In 1994, the commission issued a concept release soliciting comment on the need for, and impediments to, providing forward looking information. The release included eight alternatives to the current safe harbor suggested by commentators. The commission continues to consider the issue of safe harbor rules for forward looking information.

EDGAR. The commission issued three releases relating to EDGAR (Electronic Data Gathering, Analysis, and Retrieval System). One established September 1, 1994, as the date EDGAR filings would require financial data schedules, another adopted an updated version of the EDGAR filer manual, and the third proposed minor changes in EDGAR rules and identified some common filing mistakes.

Office of the Chief Accountant

As the principal advisor to the commission on accounting and auditing matters, the Chief Accountant makes recommendations to the commission designed to achieve compliance with accounting and financial disclosure requirements of the Federal securities laws. Thus, the SEC is responsible for rule making and interpretation that supplement GAAP and GAAS.

SAB No. 93 Issued. The Chief Accountant's office frequently publishes unofficial interpretations on accounting issues through staff accounting bulletins. For example, Staff Accounting Bulletin No. 93 (Topic 5:Z) was issued because the staff believed there had been a deterioration in compliance with authoritative literature covering the reporting of discontinued operations by public companies. SAB No. 93 provides guidance on the accounting and reporting for eight situations, including when the method of disposal is not determined, disposal not within one year, abandonment, disposal with interest retained, classification of changes in estimates, contingencies retained, planned sales of subsidiaries, and spin-offs.

Oversight of Private-Sector Activities. An important function in the mission of the Chief Accountant's Office is the oversight of private-sector standard-setting organizations. Developments in several key areas were overseen by the SEC staff. The staff worked with the FASB in the areas of derivatives, loan impairments, and stock-based compensation, with the EITF on restructuring charges--with the Accounting Standards Board (ASB) on audit risk alerts and the Accounting Standards Executive Committee (AcSEC) on advertising costs, risks and uncertainties, and environmental liabilities.

Concerned with the consistency and quality of practice before the commission, the SEC staff, in coordination with the Public Oversight Board (POB), continually reviews the quality-control activities of the accounting profession. A random sample of peer reviews is selected each year for staff review, including the peer reviewer's workpapers and the POB's oversight file. All closed-case summaries prepared by the Quality Control Inquiry Committee, which investigate allegations of audit failure in the audits of public companies, are reviewed by the SEC staff.

International Activities. The SEC continued its active participation in initiatives designed to reduce differences in accounting and auditing standards among countries. During 1994, the staff worked with the IASC on projects in the areas of earnings per share, financial instruments, intangible assets, segment reporting, and income taxes.

Together with other members of the International Organization of Securities Commissions (IOSCO), the SEC evaluated existing international standards and identified additional areas that should be addressed to develop a core set of standards. IOSCO believes improvements are required for existing international standards in the areas of research and development costs, contingencies and subsequent events, leases, retirement-benefit costs, and investments. Areas yet to be addressed include employee benefits, interim reporting, discontinued operations and other restructurings, hedging for commodities, and impairment of long-lived assets, identifiable intangibles, and goodwill.

Also in 1994, the SEC participated with the FASB in a joint project with Canadian and Mexican standard-setters to develop recommendations for consideration by the United States, Canada, Mexico, and the IASC to move toward greater comparability.

Enforcement

In 1994, the Division of Enforcement initiated a total of 497 enforcement actions, the highest number in history, an increase of more than 19% over 1993. The SEC obtained civil penalties exceeding $34 million, plus court orders for disgorgement of $730 million in ill-gotten gains. However, some payments were waived where defendants could show inability to pay.

The commission itself does not have the power to bring criminal actions, but during the year authorities working on commission-related cases won 53 convictions. The SEC opened its files to prosecutors on 451 occasions.

In addition to bringing numerous enforcement actions, the Enforcement Division issued press releases to warn investors of fraud in the areas of telecommunication technologies, e.g., wireless cable and securities purportedly issued by international banks ("prime bank" securities). The division was particularly concerned about the apparent targeting of retirement funds by promoters of the frauds.

While noting that such cases are complex and more demanding of its resources, the commission continues to be intolerant of false and misleading financial disclosure. During 1994, 31 cases were brought against accounting firms or their partners or employees; 78 cases were brought against issuers, regulated entities, or their employees. The Annual Report includes a summary of the more significant cases with endnotes that provide a reference to the related releases. Anyone seeking further information on SEC enforcement activity can consult Table 2 of the Appendix, which provides the case, release number, and date filed, organized by category of violation. *

William J. Coffey, PhD, CPA, and Lewis Schier, PhD, are professors at Pace University. Gary Illiano, MBA, CPA, is an employee of the Securities and Exchange Commission.

The SEC, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed in this article are the authors' and do not necessarily represent the views of the SEC or of Mr. Illiano's colleagues on the staff of the commission.

DECEMBER 1995 / THE CPA JOURNAL

The SEC has proposed amendments to its Regulations S-K and S-B that would allow the use of abbreviated financial statements (AFS) in documents delivered directly to investors. The proposed new Item 305 would affect annual reports and other disclosure documents including prospectuses. AFS would require a special audit report and a full set of audited financial statements to be filed with the commission and to be provided to investors upon request. Safe harbor rules would apply to information omitted under the proposal. The SEC is in the process of reviewing approximately 1,500 letters it has received on the proposed amendments to the
regulations.

Abbreviated Financial Statements Content

AFS would still require balance sheets, statements of income and cash flows, and changes in stockholders' equity that conform with GAAP and Regulation S-X. However, the notes to the financial statements would be reduced to 13 or fewer specific matters. The first two of the 13 would always be required.

The first matter (basis of presentation) would state that the financial statements were prepared using GAAP for measurement and classification, but that substantially all notes required by GAAP and the SEC's Regulation S-X have been omitted.

The second matter (accounting policies) would require a description of all significant accounting policies that affect financial statements as specified by APB Opinion No. 22 and related pronouncements.

Numbers 3 through 13 would be required where applicable to cover the following matters: changes in accounting principle, restatements and reclassifications, changes in accounting estimate, business combinations, discontinued operations, circumstances identified in explanatory language added to the independent accountant's standard report, loss contingencies, events of default under credit agreements, related party transactions, bankruptcies and quasi-reorganizations, and subsequent events.

Documents Affected

Annual Report to Shareholders. AFS would be allowed in annual reports sent to shareholders provided that full financial statements are available in the commission's public files at the time the annual report with the AFS is being used. Therefore, if the 10-K or 10-KSB containing the full financial statements were not yet filed, the annual report submitted to the commission would have to be accompanied by full financial statements.

Securities Act Disclosure Documents. The proposal would allow registrants the option of providing either full or abbreviated financial statements in Part I (the prospectus) of the registration statement. If AFS were included in the prospectus, however, full financial statements would have to be included in Part II of the registration statement unless they could be incorporated by reference from other Exchange Act filings.

Also permitted to be provided in abbreviated form would be restated financial statements, and financial statements of other entities, e.g., businesses acquired or to be acquired. Again, full financial statements would be required in Part II, unless incorporated by reference.

Regarding documents provided in exempt offerings, AFS could be included in offering circulars under Regulation A and furnished to purchasers of securities pursuant to Regulation D. Full financial statements would be provided as an exhibit to Form 1-A under Regulation A, but Regulation D issuers would continue to have no requirement to file full financial statements with the commission.

Other Documents. Where financial statements are required in proxy and information statements, registrants would be able to provide AFS and, unless already included in previously filed Exchange Act reports, full financial statements would be appended to the copies filed with the commission. AFS would be allowed for tender offers and going-private transactions, whether financial statements were required in the disclosure document or included voluntarily.

Eligibility

Registrants would be able to include AFS in the specified disclosure documents delivered to investors, provided two conditions were met. First, the report of the independent accountant on the full financial statements must not contain a disclaimer of opinion, and it must be unqualified as to scope and accounting principles used. Second, reporting companies must be current in their Exchange Act filings.

In various transactional filings, the financial statements of other entities may be required, e.g., businesses acquired or to be acquired, 50% or less owned entities accounted for by the equity method, and guarantors. In the specified disclosure documents delivered to investors, AFS for those entities would be allowed if two conditions were met. First, the registrant itself must be eligible, and second, the auditor's report on the other entity's full financial statements must be acceptable, as described above. Nevertheless, the full financial statements of the other entity still would be required to be filed with the commission.

Investment companies and business development companies would not be eligible to use AFS. Insurance companies that issue variable life insurance contracts could provide AFS in the prospectus, but only if they register on Form S-6. If they meet the eligibility requirements, foreign issuers may use AFS provided they include, where required, a footnote reconciliation to U.S. GAAP.

The use of AFS would be at a registrant's option as long as it met the eligibility criteria. Registrants would be able to include AFS in some documents and full financial statements in others. For example, the annual report could contain AFS and a subsequently filed Form S-1 registration statement could include full financial statements. Registrants could also alternate among entities, e.g., when full financial statements of an acquired business are included with the registrant's own AFS in the same form. However, within a document, annual and interim statements would have to be consistent. A prospectus with a registrant's abbreviated annual statements would have to include its abbreviated interim statements as well. Abbreviated interim financial statements would similarly be prepared in conformity with GAAP and Regulation S-X, with the note disclosure limited to the 13 items described above to the extent not disclosed in the annual AFS.

Report of the Independent Accountant

The AFS would have to be accompanied by a report of the independent accountant. The report must contain (i) a statement that the AFS were examined in connection with the audit of the full financial statements, (ii) a complete description of the opinion rendered on the full financial statements including any explanatory language, and (iii) a statement of the independent accountant's opinion that the content of the AFS complies with Item 305. The release contemplates that the accountant's report would fall within the guidance of SAS No. 62, Special Reports.

Delivery of Full Financial Statements

Full financial statements would have to be provided without charge to any person making either a written or oral request. In the disclosure document, the registrant must include a statement setting forth the registrant's obligation to provide the full financial statements and the name, address, and telephone number of the person designated, as such, to receive requests. Means of delivery were not specified, except that registrants would have to reasonably expect the information to reach the investor within five business days from the date the request is received.

Safe Harbor Provisions

The release includes a proposed Rule 435 that states that if the registrant has complied with Item 305, the full financial statements omitted from the prospectus shall be deemed to be part of the prospectus. The omission of certain notes in accordance with Item 305 shall not be deemed materially misleading or an omission of material facts under the Federal securities laws. Note that proposed Item 305 does not provide for the discretionary addition by registrants of note disclosure regarding other matters. Accordingly, the safe harbor would apply only to issuers that did not include note disclosure beyond the 13 matters specified by proposed Item 305. *

[Editor's Note: News accounts have recently reported that the SEC has put a hold on this project because of the large number of comment letters in opposition to the proposal.]

DECEMBER 1995 / THE CPA JOURNAL