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What the accountant must know about SEC requirements.

What the Accountant Must Know About SEC Requirements

The accountant who is or may become involved with SEC filing requirements must be familiar with the provisions of the SEC as it affects his or her particular requirements to optimally perform the accounting, reporting and disclosure functions. In addition, familiarity is required with regard to prospective financial statements. The practitioner must be on guard that no violations exist regarding the Accounting and Auditing Enforcement Releases. The accountant also is sometimes faced with the question of whether the company should go from private to public or vice versa. Guidelines are offered in making this decision.

SEC disclosures require a five-year summary of earnings and management's discussion and analysis of earnings. Quarterly data are also presented.

Regulation S-X Requirements

S-X requirements of the SEC govern the annual report. All financial statements presented in annual reports must conform to the S-X accounting and disclosure rules. The stockholders' report must include three-year comparative financial statements prepared in conformity with Regulation S-X. Form 10-K must be signed by a majority of the board of directors. There is significant expansion to management's discussion and analysis.

To accomplish uniformity of financial statements, S-X has been revised to bring it into conformity with generally accepted accounting principles (GAAP).

S-X's Article 3 serves as the general instructions for financial statement presentation in all disclosure documents. Mandated by the uniform instructions are:

1. Audited balance sheet of the

close of the two most recent

fiscal years. 2. Audited income statement and

changes in cash flow for each

of the three most recent fiscal

years prior to the date of the

most recent audited balance


A 10-K annual filing must be filed within 90 days subsequent to the closing of the registrant's fiscal year. Form 10-Q, a quarterly filing, must be filed with the SEC within 45 days subsequent to the end of each of the first three quarters.

In the case of registration statements, the SEC has 135 days as the essential date for ascertaining the aging of the financial statements at the anticipated effective date of the registration statement, or a proposed mailing date of the proxy statement, which includes financial statements.

Filed registration is effective 90 days subsequent to the end of the fiscal year, but prior to the 135th day. It must include audited financial statements for the last two years and the three-year income and changes in cash flows statements. If the filing is 135 days or more subsequent to the year-end, the filing has to be kept current with an unaudited interim balance sheet as of a date within 135 filing days. In addition, the filing must include an unaudited income and changes in cash flows for the interim period and for the corresponding period of the prior year.

Regulation S-X relates to the form and content of financial statements filed with the SEC. It also deals with the qualifications of accountants who report on financial statements and schedules filed with the SEC.

On occasion, financial reporting releases are issued by the SEC in connection with Regulation S-X. They cover accounting, reporting and disclosure requirements. Guidance along with acceptable and unacceptable cases of the independence of accountants are provided.

Integrated Disclosure System (IDS)

The SEC's Integrated Disclosure System consists of audited financial statements, management's discussion and analysis of operations and selected income statement and balance sheet information. The package is common to the annual report, Form 10-K, and most 1933 Act filings.

In Form 10-K (annual report), Part I includes the business, properties, litigation, security ownership of beneficial owners and management. Part II contains market information for the registrant's common stock and related security matters, selected financial information, management's discussion and analysis, financial statements and supplementary information. Part III indicates directors and executive officers, management compensation and management transactions. Part IV presents exhibits, financial schedules and Form 8-K reports (emergency filings such as a sudden lawsuit). Form 8-K is an immediate filing after a significant event materially impacts a company's financial position and operating results.

Form 10 relates to registration for the over-the-counter securities.


While forecasts are not required in SEC filings nor in the registrant's annual report, prospective data are encouraged. Prospective information need not be certified as presented by management. But the auditor is cautioned that many projections will be based upon certified information in the statements. The independent accountant should carefully go over management's forecasts for consistency with data in the certified financial statements.

Basic Information Package (BIP)

Financial disclosures for SEC filings are referred to as the Basic Information Package. BIP requirements are common to Forms S-1, S-2, S-3, 10-K and to the annual report. Some differences exist in presenting financial data on the registration forms.

The BIP consists of the following:

1. Management's discussion and

analysis of the financial

condition and results of

operations. 2. Five-year comparative

financial information. 3. Description of the registrant's

business and particular

segmental data. 4. Essential information needed

for an informed decision,

especially negative facts. A

prominent indication should

be made in the registration

statement and prospectus to

significant adverse

contingencies. 5. Data explaining the

circumstances applicable to a change

in the registrant's

independent accountant during the

prior two years. If the change

emanated over a disagreement

between the parties

regarding accounting policies and

disclosures, this should be

stated. In a similar vein, audit

scope and procedures may have

to be modified under the

circumstances. 6. Information regarding

market price of stock and


"S" Forms

New security issues involve the filing of Forms S-1, S-2 and S-3.

Form S-1 is employed by registrants in the 1934 act reporting system for less than three years and also may be employed by any registrants who opt to do so. However, the form is not used for securities of foreign governments or political subdivisions. The form requires full disclosure in the prospectus and does not allow incorporation by reference. Guidelines exist regarding non-financial substantive disclosure. Reportable information includes basic information, legal disclosures, business description, properties, management information and data regarding stockholders.

With regard to Form S-2, data may be shown in the prospectus or annual report. Information can be incorporated by reference from the annual report into the prospectus. Form S-2 applies to securities to be offered to a middle range of public companies. To use Form S-2, accountants should ensure that the following exists:

1. The registrant must have filed

reports with the SEC at least

36 months before the filing

of the registration statement. 2. The registrant since the end

of the last certified annual

report neglected to: a. Pay

dividends or sinking fund

installments on preferred stock, b.

Honor an indebtedness, or c.

Honor a lease commitment.

Form S-3 can have information incorporated by reference from Form 10-K. Form S-3 provides information already available in the market. Form S-3 is prepared if the registrant has $150 million in voting common stock as long as the holders are not affiliated with the company. Alternatively, the registrant may have $100 million in voting stock and an annual trading volume in the stock market of 3 million or more shares. The aggregate market value of the outstanding voting common stock is determined using the price the stock was last sold, or the average of the bid and asked prices, as of a date within 60 days or before the filing. Annual trading volume is the shares traded over a recurring 12-month period culminating within 60 days before the filing date. Form S-3 may also be employed for a specific primary offering of investment grade non-convertible debt, secondary offering other than by the issuer, dividend and interest reinvestment plans and exercise of conversions and warrants.

Employee benefit plans are included in Form S-8. Certain business combinations appear in Form S-15. Form S-16 is for specified primary and secondary offerings. Form S-18 is applicable to certain smaller offerings. Form S-18 can be used to register a qualified start-up company when the total offering does not exceed $7.5 million. This form may be used to register securities of any individual other than the issuer (secondary offering).

Accountants' responsibilities in connection with Form S-18 include:

1. Providing audited income

statements for two years. 2. Providing an audited balance

sheet for one year. 3. Providing an audited

statement of changes in cash flows

for two years. 4. Providing financial statements

which must be filed within

90 days of the filing date. 5. Presenting a "stub period" (if

needed to bring the financial

statements into conformity

with the 90-day requirement,

after the close of the last

fiscal year), which may be

unaudited, on a comparative basis

with the same stub period for

the previous year. 6. Providing a balance sheet

which must be filed within

90 days before the filing date

of the registration statement.

If the balance sheet is not of

the latest fiscal year, it need

not be audited. In cases where

the balance sheet is not

audited, an audited balance sheet

has to be filed within one

year except if the year-end of

the registration had ended

within 90 days before the filing

date. In that case, the

audited balance sheet may be as

of the end of the prior year. 7. Providing income statements,

statements of changes in cash

flow and statements of

stockholders' equity for each of the

two fiscal years prior to the

date of the most recent

balance sheet filed, including

any interim period. An audit

is required as of the date of

the most recent audited

balance sheet being filed.

Form S-18 is filed at a regional office of the SEC, cutting down on processing time. Less detailed disclosures are involved with S-18 than S-1, such as less information regarding pension plans, absence of the fixed charge coverage ratio, no management's discussion and analysis of the summary of earnings, less segmental reporting, less foreign activities information, cutback on order backlog data and less discussion of a number of other business activities. Required presentation includes the most recent year of an audited balance sheet, most recent two fiscal years of audited income, changes in cash flow and changes in stockholders' equity.

On a positive note, for small companies an S-18 filing only permits the use of generally accepted accounting principles (GAAP) in lieu of the SEC's Regulation S-X accounting requirements. The latter are very detailed and complex especially regarding disclosures.

Note: Avoiding Regulation S-X accounting and following GAAP will significantly reduce accounting and attorney fees.

A small business has three years to complete the transition for the application of S-X accounting requirements to the Form 8-K (annual report) filing and the Form 10-Q (quarterly) filing.

Safe Harbor Rule

Prospective information may be included in SEC registration forms. The safe harbor rule offers protection of the registrant and independent auditor for litigation for a subsequently found incorrect projection as long as the projection was undertaken in good faith and management had a reliable basis for that assessment.

According to the safe harbor rule, the plaintiff must prove that forecasts and projections did not have a reasonable basis or were not disclosed properly.

The financial projections of the rule include projecting revenue, profits, dividends, financial items, capital expenditures, capital structure, economic conditions, management plans and objectives and underlying assumptions.

Management Responsibilities

The responsibility for the accuracy and completeness of factual information contained in the registration statement lies with management. Management cannot sit idly by and just rely on statements made by accountants and attorneys. Management must properly communicate all needed factual information to recipients.

There are civil and criminal liabilities which may arise under the Securities Act of 1933. Legal liabilities may occur due to one or more of the following:

1. Significant misstatements or

omissions in the registration

statement including the

prospectus. 2. Failure to follow relevant

registration requirements. 3. Failure to furnish a

prospectus regarding particular

activities. 4. Taking part in fraud.

It should be noted that corporate officers, directors, underwriters and experts associated with the registration statement are jointly and severally liable. Civil liability may equal the full sales price of the security. Fraud is a criminal act that can result in a jail term.

Enforcement actions of the SEC are provided in Accounting and Auditing Enforcement Releases (AAERs).

Injured Stockholder Rights

SEC regulations exist to protect stockholder rights in the event a corporate merger or takeover takes place and the affected stockholders have suffered financial damages as a result of misrepresentations or inadequate disclosures. Typically, federal jurisdiction is more advantageous for the injured party than initiating an action in state court. Thus, it is in the accountant's best interest to move in the direction of a state trial.

As per Section 10 and Rule 10b-5 of the SEC Act of 1934, injured minority stockholders can proceed under federal law when no remedy is available in a state court. The theory of constructive receipt is involved as long as the omission or misrepresentation is sufficiently material.

In general, plaintiffs favor the federal court rather than the state court route due to the availability of nationwide service, liberal class action rules, jury trials and relief from state security-for-expense requirements. Another problem in state court for the minority stockholder is that he or she is typically limited to recover the appraised fair market value of the stock. Since the plaintiff will benefit from federal activity, the accountant and/or attorney must push strenuously to move on the state level.

In the state court case, Smith v. Van Gorkom, the stockholders were awarded the fair value of their investment but were denied the asked-for rescission of a cash-out merger even though the court determined that the board of directors acted improperly by not disclosing material information prior to receiving stockholder approval. Imagine if this were tried in federal court. The company may have been served an injunction against the merger. Further, management runs the risk in federal court that monetary damages may be awarded based on the losses suffered by the investor rather than just the worth of the shares.

Should a Company Go Public?

In deciding whether to go public, consideration should be given to the positive aspects, negative factors and financing sources. The benefits must outweigh the costs and disadvantages. Lengthy advance planning is needed to ascertain the merits of a public offering.

There are many advantages to a public offering:

1. Prestige and recognition for

the entity. 2. Increased revenue base for

services and products (customers

and suppliers may eventually

become stockholders). 3. Availability of significant

funds for such purposes as

working capital requirements,

development of new products,

capital expansion, paying-off

debt and diversification. 4. Improved employee

recruitment and retention as a

result of publicly traded stock

or options. 5. Possible expansion through

the purchase of other

businesses. A publicly traded

company is in a more

favorable situation to finance

acquisitions with its own stock

as an alternative to investing

in cash. 6. Increase in financial leverage

as a result of issuance of

equities, permitting the firm to

have readier available sources

of debt at attractive interest

rates. 7. Readier marketability for the


Going Private

To take a company private, sound reasons must exist for the SEC to acquiesce. Expressly prohibited are fraudulent, deceptive and manipulative practices regarding private transactions. Proper disclosures and dissemination requirements exist to guard against unfair handling of existing public stockholders.

Before the accountant should recommend going private, consideration must be given to consent and participation of majority stockholders, involvement of minority stockholders and management input. When private owners continue to manage the company on a "going concern" basis, a careful review should be made of the financial statements over the years. Factors to take into account are the industry, company position, risk level, future prospects and effect on worth of the business.

There are alternative approaches to going private, and forecasts should be prepared to ascertain which method is best in guarding public stockholder rights.

The accountant must ascertain an equitable price for minority stockholders when a firm goes private. In gauging what the price should be, the practitioner must take into account the fact that marketability and liquidity will be lost. There can be no unfair pressure placed on minority stockholders to sell their stock.

As per SEC Exchange Rule 13e-3, the following information must be disclosed to shareholders on Schedule 13e-3 in the consummation of a private transaction:

1. Balance sheet information

including working capital,

total assets and stockholders'

equity. 2. Income statement information

including net sales,

operating revenues, other revenues,

income before extraordinary

items and net income. 3. Average shares outstanding

for recent years adjusted for

stock dividends and stock

splits for the last two years. 4. Fixed charge coverage ratio

for the last two years. 5. Per share disclosure

providing for income per common

share before extraordinary

items, extraordinary items,

earnings per share (primary

and fully diluted) and book

value per share. 6. Pro forma financial data

revealing the effect of the method

selected to finalize the

transaction of going private.

There should exist audited financial statements for the previous two years. Also to be presented are unaudited interim financial statements for the latest year-to-date interim period and corresponding period of the prior year.

Additional information required includes:

1. Identification and credentials

of individuals filing

Schedule 3e3. 2. A statement indicating that

a fair or unfair transaction

has occurred to an

unaffiliated security holder. The

supporting reasons for a fair

offer must be explicitly stated. 3. Provisions of the transaction. 4. Previous contracts,

transactions and negotiations. 5. Basis and amount of funds to

finance the transaction. 6. Issuer's proposed plans. 7. Objectives, alternative courses

of action, reasons and impact

of going private.


This article has provided the practitioner with essential guidance as to the important provisions of SEC statutes as they affect accounting, reporting and disclosure requirements, and the accountant must be cognizant of the possible penalties for failure to conform to SEC dictates.

The client will often seek the practitioner's advice as to whether the company should change from public to private or private to public. Important considerations have to be taken into account in resolving this dilemma. Generally speaking, an awareness of the numerous SEC requirements and responsibilities will enable accountants to better serve the client and protect themselves.

Peter Chiu, JD, is a financial consultant and professor of accounting at Queens College of the City University of New York. Joel Siegel, PhD, CPA, is an accounting consultant and professor of accounting at Queens College of the City University of New York.
COPYRIGHT 1990 National Society of Public Accountants
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990 Gale, Cengage Learning. All rights reserved.

Article Details
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Author:Chiu, Peter; Siegel, Joel
Publication:The National Public Accountant
Date:Nov 1, 1990
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