CASH FLOW
RISKS
RESOURCE MANAGEMENT
INTERNAL CONTROLS
I.T. MANAGEMENT FINANCIAL REPORTING
TAX M&A REGULATORY REPORTING
TECHNICAL ACCOUNTING
August 2013 Essential Briefings FASB EXPOSURE DRAFT ON GOING CONCERN
REGULATORY REPORTING ____________________________________________________________ SEC Proposed Changes to Regulation D, Form D, and Rule 156
FINANCIAL REPORTING ____________________________________________________________ Restatements: Where They Come From
INTERNAL CONTROLS ____________________________________________________________ COSO Framework Implementation
Contents August 2013
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ESSENTIAL BRIEFINGS 2 FA SB E X P O SUR E D R A F T O N G OI NG C O N C E R N In June 2013, the FASB issued an exposure draft, which would require management to assess going concern.
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REGULATORY REPORTING 3 SE C P ROP O SE D C H A NG E S T O R EGUL AT IO N D, F OR M D, A N D RUL E 156 The Securities and Exchange Commission proposed amendments to Rule 506 of Regulation D and to Form D to implement Section 201(a)(1) of the Jumpstart Our Business Startups Act the (“JOBS Act”) and Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).
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FINANCIAL REPORTING 5 R E S TAT E ME N T S: W HE R E T HE Y C OME F ROM Ever since the days of Enron, financial restatements have been considered big news.
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INTERNAL CONTROLS 7 C O S O F R A ME WOR K IMP L E ME N TAT IO N The Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) issued an update to its Internal Control – Integrated Framework on May 11, 2013, the first such update in over twenty years.
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ESSENTIAL BRIEFINGS
FASB EXPOSURE DRAFT ON GOING CONCERN BY SUZIE DORAN | PARTNER
SDoran@SingerLewak.com | 310.477.3924
SUMMARY: In June 2013, the FASB issued an exposure draft, which would require management to assess going concern. If the company is determined by management to have met either (i) the more likely than not assessment that it will be unable to meet its obligations within 12 months after the financial statement date or (ii) known or probable that the company will be unable to meet its obligations under the ordinary course of business within 24 months after the financial statement date, then, management would need to disclose additional information about going concern in the financial statements. SEC filers would be required to analyze if there is substantial doubt about the company’s ability to continue as a going concern, which would result in required disclosures that would use terms such as “going concern” and the findings supporting the “substantial doubt” conclusion. Comments regarding the exposure draft are due by September 24, 2013. B AC KG RO UN D: FASB proposed ASU, “Presentation of Financial Statements, Disclosure of Uncertainties about an Entity’s Going Concern Pre-
• Internal matters such as substantial dependence on success of proposed project and a need to significantly revise operations sumption” to give guidance on management’s responsibilities on evaluation and disclosing going concern uncertainties. Without specific guidance on disclosures regarding going concern, divergent practices exist between companies. For each reporting period, management is expected to analyze going concern for a period of 24 months from the balance sheet date. An SEC filer is also expected to evaluate if there is substantial doubt regarding going concern for the same period.
• External matters such as litigation and loss of a key supplier, customer, or patent FINANCIAL STATE ME NT DISCLOSURE S: The following are required disclosures: • Primary conditions and events that resulted in the company being unable to meet obligations • Potential impact of those conditions and events on the company • Management’s evaluation of the significance of those conditions and events
The proposed ASU gives the following as examples of conditions and events that may indicate going concern:
• Mitigating conditions and events
• Negative trends in operating metrics such as operating losses and negative working capital
NE X T STE PS:
• Indications of financial difficulties such as defaulting on loans, inability to get credit from suppliers and a history of restructuring debt or getting new capital
• Management’s plans to address the company’s inability to meet its obligations Comments are due by September 24, 2103. An effective date will be determined after all feedback has been considered. SUZIE DORAN CAN BE REACHED AT SDORAN@SINGERLEWAK.COM OR 310.477.3924 August 2013
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R E G U L ATO RY R E PO R TI N G
SEC PROPOSED CHANGES TO REGULATION D, FORM D AND RULE 156 BY CONNIE KWONG | SENIOR MANAGER CKwong@SingerLewak.com | 310.477.3924
The Securities and Exchange Commission proposed amendments to Rule 506 of Regulation D and to Form D to implement Section 201(a)(1) of the Jumpstart Our Business Startups Act the (“JOBS Act”) and Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The amendment permits the use of general solicitation and general advertising when conducting an offering under the JOBS Act (“Rule 506(c)”). It also disqualifies issuers and other market participants from relying on Rule 506 if “felons and other ‘bad actors’” are participating in the offering (“Rule 506(d)”). This amendment also changes some of the filing requirements of the Form D, such as requiring the filing of a Form D in Rule 506(c) offerings before the issuer engages in general solicitation and requiring the filing of a closing amendment to Form D after the termination of any Rule 506 offering. Private funds would also be required to include a legend 3 | SingerLewak
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disclosing that the securities being offered are not subject to the protections of the Investment Company Act of 1940. Additional disclosures in written general solicitation materials will include performance data so that potential investors are aware that there are limitations on the usefulness of such data and provide context to understand the data presented. This amendment also requires submission of written general solicitation materials used in Rule 506(c) offerings to the Commission and requires an issuer to include additional information about offerings conducted in reliance of Regulation D. Finally, the Commission is also proposing to amend Rule 156 under the Securities Act, which interprets the antifraud provi-
sions of the federal securities laws in connection with sales literature used by investment companies, to apply to the sales literature of private funds because the Commission believes it is important for private funds to consider the Commission’s views on the applicability of the antifraud provisions to their sales literature. The Commission is also soliciting comment on a recommendation made by commenters on the Rule 506(c) Proposing Release to mandate additional manner and content restrictions on written general solicitation materials used by private funds.
The amendment permits the use of general solicitation and general advertising when conducting an offering under the JOBS Act (“Rule 506(c)”) The Commission is also requesting comment on the definition of accredited investor as it relates to natural persons.
As the Commission will need to be aware of developments in the Rule 506 market after the effectiveness of Rule 506(c), the Commission directed the Commission staff to execute a comprehensive work plan upon effectiveness of Rule 506(c) (“Rule 506(c) Work Plan”) to review and analyze the use of Rule 506(c). The Commission staff will: • Evaluate the range of purchaser verification practices used by issuers and other participants in these offerings, including whether these verification practices are excluding or identifying non-accredited investors • Evaluate whether the absence of the prohibition against general solicitation has been accompanied by an increase in sales to non-accredited investors
• Assess whether the availability of Rule 506(c) has facilitated new capital formation or has shifted capital formation from registered offerings and unregistered non-Rule 506(c) offerings to Rule 506(c) offerings • Examine the information submitted or available to the Commission on Rule 506(c) offerings, including the information in Form D filings and the form and content of written general solicitation materials submitted to the Commission • Monitor the market for Rule 506(c) offerings for increased incidence of fraud and develop risk characteristics regarding the types of issuers and market participants that conduct or participate in Rule 506(c) offerings and the types of investors
targeted in these offerings to assist with this effort • Incorporate an evaluation of the practices in Rule 506(c) offerings in the staff’s examinations of registered broker-dealers and registered investment advisers • Coordinate with state securities regulators on sharing information about Rule 506(c) offerings Comments should be received on or before September 23, 2013.
CONNIE KWONG CAN BE REACHED AT CKWONG@SINGERLEWAK.COM OR 310.477.3924
August 2013
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FINANCIAL REPORTING
RESTATEMENTS: WHERE THEY COME FROM Ever since the days of Enron, financial restatements have been considered big news. Not all accounting mistakes are created equal, of course: thousands are discovered every year, but most are not material enough even to warrant a disclosure. A few, though, are severe enough to cause a restatement. The consequences could be grim: as serious as Enron’s bankruptcy, or as mild as a CFO losing their job. In our 2012 restatements report, Audit Analytics disclosed that the number of financial restatements, after a period of turbulence, had finally stabilized. Average number of days restated is an indicator that measures the number of days that the restatement extends back. According to the same report, this indicator remained steady for three years dating back from the report. On the other hand, an absolute value of the indicator averaged at 534 days. This means that companies had to correct an average of a year and a half of financial data. This raises a major question: why now? If the errors went undetected for so long, how were they finally discovered? 5 | SingerLewak
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• GAAP/Foreign Accounting Principle failure or misapplication refers to errors that were caused by unintentional mistakes in the application of GAAP, IFRS, or foreign accounting principles. Most financial restatements fall into this category.
Audit Analytics identifies three categories of financial restatements. • Financial fraud refers to restatements that were caused by intentional manipulation of financial data or by misappropriation of assets. This category is potentially the most harmful, since it raises questions about the integrity of the management, and about the overall health of the corporate environment. As harmful as they are, though, fraud-related restatements are relatively rare. In 2012, only 11 restatements were related to intentional misrepresentation of data. • Clerical errors refers to restatements that were caused by simple clerical and bookkeeping errors, such as mathematical mistakes.
Most unintentional errors are discovered during annual audits. Companies whose financial year coincides with the calendar year typically review and prepare their annual reports between February and April of the subsequent year. Out of the 768 restatements covered in the 2012 Audit Analytics restatement report, 295 restatements, or 38%, were disclosed during this period. In some cases, new SEC guidance may also cause a company to review its accounting policies. In February 2005, the SEC issued a clarification on lease accounting. The end result was more than 285 lease-related financial restatements in 2005 alone. Sometimes a restatement by a large player may cause a snowball effect: a number of the company’s industry peers will likely find similar issues in their own
reporting, and may also issue a restatement. During the end of 2005 and beginning of 2006, a number of analytical reports suggested an unusual correlation between the stock prices of various companies, and the number of options granted to their key employees. These revelations, while targeted at a few specific companies, caused an industrywide avalanche of restatements related to deferred compensation practices. Since top executives were involved, investors perceived these restatements as very serious. In some cases, the SEC and the DOJ opened formal investigations.
Sometimes a restatement by a large player may cause a snowball effect
with the SEC. Interestingly, only 49 companies indicated in their restatements disclosure that the SEC was in any way involved in the restatement process.
Least-discussed among restatement triggers are routine examinations by the SEC. Comment letters do not guarantee a restatement. In some cases, errors are not material, while in others, the SEC will raise questions about errors that have already been disclosed. Still, in 2012 alone, 74 companies explicitly stated in their comment letters that they would restate financial statements as a result of discussions
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INTERNAL CONTROLS
COSO FRAMEWORK IMPLEMENTATION BY AARON SULLIVAN | SENIOR MANAGER ASullivan@SingerLewak.com | 310.477.3924
The Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) issued an update to its Internal Control – Integrated Framework on May 11, 2013, the first such update in over twenty years. Originally published in 1992, The Internal Control – Integrated Framework has become a cornerstone used by CFOs and auditors alike in designing, implementing, and evaluating internal controls over financial reporting. The Framework gained acceptance following financial control failures in the early part of the millennium, and is currently the most widely used framework in the United States with widespread use internationally. The updated Framework is intended to reflect the many changes in business and operating environments that have occurred since the original framework was authored. Along with these contextual changes, practical lessons learned in applying the original Framework have also been incorporated. The underlying principles and concepts embed-
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superseded. Companies using the Framework for external reporting purposes are expected to clearly disclose which framework they are using during the transition period.
ded in the original Framework have not changed; they are now codified in the updated Framework. Seventeen principles now underpin the existing five internal control components (control environment, risk assessment, control activities, information & communication, and monitoring). The original Framework was primarily used for internal control over financial reporting and COSO has expanded its reach by focusing on three broad categories which include operations, overall reporting (including non-external financial reporting), and compliance. COSO has considered a need for a transition period and will continue to make the original Framework available for use until December 15, 2014, at which point it will be considered
To aid companies in their transition, COSO has published a document outlining a best practices approach authored by J. Stephen McNally, CPA Finance Director and Controller at Campbell Soup Company. The plan outlines a five step process for rolling out the transition to the 2013 Framework: • Develop awareness, expertise and alignment -- Build internal awareness among the resident SOX subject matter experts in your company. COSO has issued a number of publications that will provide a good starting point. • Conduct preliminary impact assessment -- Map your existing system of internal control against the updated Framework. This will determine the degree of work required to complete
the transition. Instead of mapping to the five components of internal control, companies should map to the seventeen principles that underpin the five components. This will enable companies to identify gaps in internal control design and remediate. • Facilitate broad awareness, training and comprehensive assessment -- Build awareness companywide outside of the SOX team involved in Steps 1 and 2. Consider including significant stakeholders such as the board of directors, audit committee, operational management, process owners and internal audit. • Develop and execute COSO transition plan for SOX compliance -- The transition plan may
entail three phases – i) documentation and evaluation; ii) validation testing and gap remediation; and iii) external review and testing. • Drive continuous improvement -- Ensure appropriate tone at the top, aim to continuously improve control reporting and communication and embed internal control responsibility into the company’s culture and processes. The Securities and Exchange Commission has heighted the importance of this transition document, with chief accountant Paul Beswick drawing attention to the document during his speech at the 32nd Annual SEC and Financial Reporting Institute Conference “SEC staff plans to monitor the transition for issuers using the 1992 framework to evaluate
whether and if any staff or Commission actions become necessary or appropriate at some point in the future.” He stated, “However, at this time, I’ll simply refer users of the COSO framework to the statements COSO has made about their new framework and their thoughts about transition.” Further information including the detailed transition plan can be located at www.coso.org. Please contact us if you have any questions on how this impacts your internal control over financial reporting design, implementation, or assessment in the coming months.
AARON SULLIVAN CAN BE REACHED AT ASULLIVAN@SINGERLEWAK.COM OR 310.477.3924 August 2013
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