1 IMA’s 92 nd Annual Conference © 2011 Institute of Management Accountants. All rights reserved. SEC Update: Likely Impacts for Boards, Management Teams

1IMA’s 92nd Annual Conference © 2011 Institute of Management Accountants. All rights reserved.

SEC Update: Likely Impacts for Boards, Management Teams and StaffAuthored & Presented byRon Kral, MBA, CPA, CMA Candela Solutions LLCManaging PartnerTuesday, June 7th – 3:45pm – 5:00pm

2

Learning Objectives

• Identify the latest hot-buttons through SEC enforcement actions, comment letters, and speeches

• Reveal the latest developments from the Securities and Exchange Commission (SEC), including Dodd-Frank

• Understand the latest news regarding the PCAOB, IFRS and XBRL

• Gain insights on future regulatory and enforcement trends

• Identify activities to mitigate risks of noncompliance to stay within the good graces of the SEC.IMA’s 92nd Annual Conference

© 2011 Institute of Management Accountants. All rights reserved.

3

The All Powerful SEC!

• Mission: To protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation

• Approves public company auditing standards from the Public Company Accounting Oversight Board (PCAOB)

• Designated the Financial Accounting Standards Board (FASB) for establishing accounting standards that govern the preparation of financial reports by nongovernmental entitiesIMA’s 92nd Annual Conference



The next several slides are extracted from this report

SEC FY 2010 Performance and Accountability Report

5

SEC’s Financial Statements & Independent auditors

• The U.S. Government Accountability Office, affirmed that the SEC’s financial statements are presented fairly in all material respects in conformity with U.S.GAAP.

• Two material weaknesses in internal controls over financial reporting:

A combination of information system deficiencies, many that have existed since SEC began preparing financial statements in FY04. These deficiencies jeopardize the confidentiality, availability, and integrity of information processed by SEC’s key financial reporting systems.

Another in financial reporting and accounting processes representing a combination of deficiencies in financial reporting, budgetary resources, filing fees, disgorgement and penalty transactions, and required supplementary information.

IMA’s 92nd Annual Conference © 2011 Institute of Management Accountants. All rights reserved.

6

SEC Organization Chart


7

SEC Budget Breakdown: The Good, the Bad, and the Ugly(Source: Compliance Week, Bruce Carton, April 14, 2011)


http://www.securitiesdocket.com/wp-content/uploads/2011/04/secbudgetchart.png

8

3 of 10 SEC Major Programs


9

Enforcement Cases

• In FY 2010, the SEC brought 681 enforcement cases covering a broad spectrum of financial wrongdoing.

• Financial Crisis - defrauding investors by misstating and omitting key facts

Goldman Sachs (paid $550 million in penalties and disgorgement)Citigroup and two senior executivesNew Century - three former officersICP Asset Management, its president and two affiliated firms


10

681 Enforcement Cases - continued

• Return of Monies to Harmed Investors - The agency also returned approximately $2.2 billion dollars to investors as a result of SEC enforcement actions.

State Street Bank and Trust: Agreed to distribute $300 million+ to investors who lost money during the subprime market meltdownReserve Primary Fund: Completed the distribution of $3.4 billion in assets to investors who held shares of the fund when its net asset value fell below $1 per share (fund exposure to Lehman Brothers)


11


• Insider Trading - both by individuals and by large-scale institutional traders.

Galleon, Raj Rajaratnam’s New York-based hedge fund advisory firm generated more than $33 million in illicit gains. The SEC also charged six others involved in the scheme, including senior executives at IBM, Intel, and McKinsey & Company. Late in 2010 the SEC broadened its case, charging 13 additional individuals and entities.

Largest hedge fund insider trading investigation to date.


12


• Auditors - By focusing on the auditors who sign off on companies’ reporting, the SEC deters Enron-type accounting fraud that might cost investors billions.

Ernst & Young LLP

• Offering Frauds/Ponzi Schemes - aided by the adoption of significant post-Madoff reforms and the establishment of the Asset Management Unit, which continues to uncover numerous large-scale frauds.

Meredon MiningIMA’s 92nd Annual Conference © 2011 Institute of Management Accountants. All rights reserved.

13

681 Enforcement Cases - continued• Foreign Corrupt Practices Act - Illegal payments

to win business overseas. This is a renewed focus on these practices in recent years.

ENI agreed to pay $125 million, and Snamprogetti (former Dutch subsidiary) paid an additional $240 million penalty to settle separate criminal proceedings by the U.S.Department of Justice. Allegedly hired two agents who funneled $180 million+ in bribes to Nigerian officials to obtain contracts

Daimler AG agreed to pay $91.4 million in disgorgement to settle charges of repeated and systematic practices of paying bribes to foreign government officials to secure business in Asia, Africa, Eastern Europe, and the Middle East (Daimler also agreed to pay $93.6 million settle charges by the U.S.Department of Justice)


14

681 Enforcement Cases - continued• Financial Fraud - Cost investors billions in lost equity.

Both companies and corporate officers are accountable for timely and honest reporting.

Dell Inc. failed to disclose material information to investors and used fraudulent accounting to falsely show that the company was consistently meeting earnings targets. Dell agreed to pay a $100 million penalty. Dell’s Chairman and CEO, former CEO, and former CFO were also charged and each agreed to pay either a $3 to $4 million penalty.

• Municipal Securities and Public Pensions - SEC has focused on ensuring that investors are aware of factors which could affect the ability of municipalities to meet their financial obligations.

New Jersey became the first state ever charged by the SEC for violations of federal securities laws, when it was charged for failing to disclose it was underfunding the state’s two largest pension plans.


15

Wall Street Reform(Source: SEC FY 2010 Performance and Accountability Report)

• “On July 21, President Obama signed into law Dodd-Frank, the most significant piece of financial reform legislation since the 1930s. Dodd-Frank gives the SEC significant new investor protection responsibilities and provides new tools with which to carry out agency responsibilities, old and new.”

• “Over the two years following the bill-signing, the SEC will be responsible for more than 100 new rulemakings, 20 reports and five new offices to be created within the agency. While this is a significant task, the SEC continues to fulfill both its mandates under the Act and its pre-existing responsibilities.”



17

Dodd-Frank Act will Lead to Several Important SEC Actions

• Over-the-Counter Derivatives: Requires a comprehensive framework for the regulation of the over-the-counter derivatives market.

• Executive Compensation: In 2011, the SEC will finalize a number of corporate governance rules, with a particular focus on executive compensation.

Shareholders to have advisory say-on-pay votes on executive compensation at all companies at least once every three years.

Companies to calculate and disclose the median total compensation of all employees, and the ratio of CEO compensation to that figure.


18

Dodd-Frank Act will Lead to Several Important SEC Actions

• Executive Compensation – continued

Companies to disclose the relationship between senior executives’ compensation and the company’s financial performance.

SEC to adopt rules requiring stock exchanges to set forth listing standards for compensation committees including independence requirements (see SEC release #33-9199 & #34-64149 for proposal).

• Credit Rating Agencies: Builds on existing SEC authority to designate Nationally Recognized Statistical Rating Organizations (NRSROs), requiring the SEC to adopt rules designed to improve the accuracy of ratings.


19

Implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act — Dates to be Determined(Source: http://www.sec.gov/spotlight/dodd-frank/dates_to_be_determined.shtml)The following activities were deferred due to budget

uncertainty, and are currently being reassessed in light of the FY 2011 budget.



http://blogs-images.forbes.com/benkerschberg/files/2011/04/whistle_58-large.jpeg

21

Whistleblower Program

• Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act provides that the SEC shall pay awards to eligible whistleblowers who voluntarily provides original information to the SEC that leads to a successful enforcement action yielding monetary sanctions of over $1 million.

The award amount is required to be between 10 percent and 30 percent of the total monetary sanctions collected in the SEC’s action or any related action such as in a criminal case.

• The Dodd-Frank Act also expressly prohibits retaliation by employers against whistleblowers and provides them with a private cause of action in the event that they are discharged or discriminated against by their employers.


22

Congress created the IRS Whistleblower Office and a new tax whistleblower program in 2006• Similar to the proposed SEC whistleblower provision, the IRS

program – contained in section 7623 of the Internal Revenue Code – provides whistleblowers a reward of up to 30 percent of any tax, interest, penalties or additional amounts collected based on provided information.

• Earlier this year, the IRS paid a $1.1 million reward to an anonymous whistleblower for information, originally supplied in 1999, that exposed an alleged tax fraud scheme by Enron, Bankers Trust and others before the company collapsed.

The IRS made the award under the previous whistleblower program (known as the IRS 211 program), which allowed an award up to 15 percent of the tax funds the IRS recovered.IMA’s 92nd Annual Conference


23

SEC Proposed Rules for Implementing the Whistleblower Provisions (Release No. 34-63237)• A controversial aspect of the proposed rules is the

possibility that they might encourage whistleblowers to report potential violations to the SEC but not through internal company reporting processes, thereby undermining the ability of a company and its auditors to consider the impact of the potential violation on the company financial statements on a timely basis.

• Consequences could include an increase in:

legal fees for advice,

costs incurred responding to investigations, and

caution and documentation to protect whistleblowers in light of federal laws that protect them.


24

Auditor Reporting on Internal Control Over Financial Reporting (SEC Release #33-9142 & #34-62914)

• The Dodd-Frank Act exempted non-accelerated filers from the requirement to have their auditors opine on the effectiveness of their ICFR (SOX-404(b)) through the Dodd-Frank Act.

This is now Section 404(c) of SOX, which provides that Section 404(b) does not apply for ‘non-accelerated’ filers

• The SEC’s rulemaking also made the following changes:

Non-accelerated filers’ management reports on ICFR are now considered filed, not furnished, under the Securities Exchange Act of 1934. This subjects the reports to a higher level of liability; and

Non-accelerated filers are no longer required to provide a statement within management’s report that an auditors’ report on ICFR has not been provided. IMA’s 92nd Annual Conference © 2011 Institute of Management Accountants. All rights reserved.

25

Internal Control Over Financial Reporting Study• Dodd-Frank Act (Section 989G(b)) required the

SEC to study:How it can reduce the burden of the ICFR auditor attestation requirement on small accelerated filers with public floats between $75 million and $250 million, andWhether reducing the compliance burden or completely exempting such companies from the requirement would encourage companies undertaking initial public offerings (IPOs) to list on exchanges in the U.S.IMA’s 92nd Annual Conference


26

Study and Recommendations on Section 404(b) of the Sarbanes-Oxley Act of 2002: For Issuers With Public Float Between $75 and $250 Million (SEC Staff, April 2011)

• Among the findings of the SEC Staff Study are:The 2007 reforms of the SEC’s June 2007 interpretive release and the PCAOB’s adoption of AS 5 had the intended effect of reducing the compliance burden and improving implementation of Section 404.

The costs of Section 404(b) have declined since the SEC first implemented the requirements of Section 404, particularly in response to the 2007 reforms.

Investors generally view the auditor‘s attestation on ICFR as beneficial.

Financial reporting is more reliable when the auditor is involved with ICFR assessments.

There is not conclusive evidence linking the requirements of Section 404(b) to listing decisions of the studied range of issuers.


27

XBRL Developments

• XBRL interactive data submissions began for the second phase-in group, and the first group started detail tagging their XBRL submissions.

• The staff updated guidance regarding compliance with the XBRL rules in its Compliance and Disclosure Interpretations (C&DIs).

• In order to identify and communicate common implementation problems, the staff reviewed several XBRL submissions and published its observations.


28

Areas of Frequent SEC Staff Comment: Loss Contingency Disclosures

• Currently, under FASB ASC 450, an estimated loss shall be accrued by a charge to income if both of the following conditions are met:

Information available before the financial statements are issued indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements.

The amount of loss can be reasonably estimated.• An entity shall disclose information about a contingency if

there is at least a reasonable possibility (that is, more than remote possibility) that a loss may have been incurred regardless of whether the entity has accrued for such a loss (or any portion of that loss)


29

Areas of Frequent SEC Staff Comment: Loss Contingency Disclosures• SEC staff believes that companies are not providing adequate disclosures about loss contingencies, especially regarding reasonably possible losses that are not accrued. They want more disclosure on:

The nature of the contingency; and

An estimate of the possible loss or range of loss or a statement that such an estimate cannot be made.

• The staff says companies can comply in one of three ways:

State the amount or range of potential loss;

State that the amount of potential loss can’t be estimated. However, staff has cautioned that issuers must try to estimate the amount of the potential loss before taking the last approach.


30

Areas of Frequent SEC Staff Comment:Potential Long-Lived Asset & Goodwill Impairment• As a business experiences a downturn, the SEC staff will

consider whether the company should have recorded impairment charges on its long-lived assets and goodwill. SEC scrutiny can be triggered by a significant decreases in revenue and gross margin, business restructurings, sales of assets associated with discontinued operations, etc.

• If a registrant defines goodwill impairment as a critical accounting policy because impairment could materially impact the company’s operating results, the staff believes the details of known trends or uncertainties that are reasonably likely to materially affect future operating results should be disclosed in the MD&A.


31

Areas of Frequent SEC Staff Comment:Valuations

• SEC staff is concerned about inadequate disclosure on how an issuer estimated the fair value of a reporting unit or an indefinite-lived asset. SEC staff often asks the issuer to expand its disclosure to discuss:

The method used to value the asset or reporting unit (e.g., income, market, or replacement cost);

General descriptions of the valuation techniques or models used;

Key assumptions and the basis for the assumptions;

How the technique or model was validated;

How sensitive the fair value estimate was to the significant inputs used; and

If any of these items have changed since the prior valuation, the reasons why the changes were made.


32

Areas of Frequent SEC Staff Comment:Segments

• The SEC staff expects strict compliance with segments reporting disclosures required by ASC 280-10 (formerly FAS 131). The staff:

Will question inconsistencies between the segments identified in the audited financial statements and statements about the way management views the business made in the business section, MD&A, and materials that are publicly available on the issuer’s website.

May request internal operating reports that are reviewed by the chief operating decision maker to support the segments disclosed by the issuer.


33

Areas of Frequent SEC Staff Comment: Non-GAAP Measures

• This topics continues to be high on the SEC’s radar screen. Specifically, they are concerned about:

Inconsistencies

Confusing measures

Full non-GAAP income statements – Staff believes this is inappropriate since it attaches undue prominence to the non-GAAP info.

Adjustments – measures that includes adjustments to the standard definition of EBITDA should not be labeled “EBITDA.”

Cash flows per share – per share data, other than that relating to net income, net assets and dividends, should be avoided.


34

Pressure on the Company


PCAOB

Company

Investors

Public

SEC

Auditors

35

Public Company Accounting Oversight Board (PCAOB)


1. Establish Auditing Standards

2. Register Accounting Firms

3. Conduct Inspections of Accounting Firms

4. Conduct Investigations and Disciplinary Proceedings

36

PCAOB Budget – Total Outlays(Source: PCAOB.org – 2011 Annual Budget, except 2008 from 2010 Annual Budget)

• Outlays primarily funded through an annual accounting support fee paid for annually by “issuers” based on their average monthly U.S. equity market capitalization or net asset value.

• The 2011 Budget supports a 13% increase in staff from 636 to 717 positions. The greatest increase in staffing supports our expanded responsibilities to oversee broker-dealer audits and includes new positions in Inspections, Enforcement and Research and Analysis. (Source: pcaobus.org/News/Speech/Pages/11232010_HarrisBudgetStrategicPlan.aspx)


2008 Actual 2009 Actual 2010 Budget 2011 Budget

$130,214,000 $148,660,000 $183,258,000 $204,381,000

37

Statement on Strategic Plan for 2010–2014 and 2011 Budget(Source: pcaobus.org/News/Speech/Pages/11232010_HarrisBudgetStrategicPlan.aspx)• Auditing practices and quality control systems need to

continue to improve in audit areas made more difficult by the crisis. These include:

Fair value measurements;

Allowances for loan losses;

Off-balance-sheet structures;

Impairment determinations;

Revenue recognition;

Inventory valuation; and,

Income taxes.


38

New PCAOB Auditing Standards on Risk:Approved by the SEC on 12-23-10 per Release #34-63606

The new standards are effective for audits of fiscal years beginning on or after December 15, 2010:

8. Audit Risk

9. Audit Planning

10. Supervision of the Audit Engagement

11. Consideration of Materiality in Planning and Performing an Audit

12. Identifying and Assessing Risks of Material Misstatement

13. The Auditor's Responses to the Risks of Material Misstatement

14. Evaluating Audit Results

15. Audit EvidenceIMA’s 92nd Annual Conference © 2011 Institute of Management Accountants. All rights reserved.

39

Three Particularly Important Aspects of Auditor’s Assessment of and Response to Risk1. Alignment with Auditing Standard No. 5Clarifies that the risk assessment process is basically the same, regardless if performing only an audit of the financial statements or an integrated financial statement and internal control audit

2. Financial Statement Disclosures (i.e. footnotes)Enhances the requirements for evaluating (i.e., testing) disclosures and focusing on the risk of material misstatement during the planning stages

3. Consideration of FraudContains beefed-up requirements on the auditor's responsibilities to consider the possibility of fraud, including increased emphasis on consideration of potential management bias and risks related to missing or incomplete disclosures


40

PCAOB Proposed Auditing Standard:Communications with Audit CommitteesPCAOB Release No. 2010-001, March 29, 2010• Communication of an overview of audit strategy,

including:

(a) a discussion of significant risks;

(b) the use of the internal audit function; and

(c) the roles, responsibilities, and location of firms participating in the audit;

• Communication regarding critical accounting policies, practices, and estimates

• Communication regarding the auditor’s evaluation of a company’s ability to continue as a going concern

• Evaluation by the auditor of the adequacy of the two-way communications with the audit committee


41

Evaluation of Adequacy of the Two-Way Communications with the Audit Committee

1. Communication of significant risks identified by the auditor gives the audit committee an opportunity to understand the auditor's view of the most important risks of material misstatements, as well as the ability to communicate its views relating to those risks based on its knowledge of the company

2. The auditor's understanding of the audit committee's view of the company's risks could assist in the development of the auditor's risk assessment and audit strategy, ultimately improving audit quality


42

The 2-way Communication Evaluation goes beyond a “Check-Box” Mentality to Include:• Appropriateness and timeliness of actions taken by

audit committee in response to matters raised by auditor

• Openness of the audit committee in its communications with the auditor

• Willingness and capacity of the audit committee to meet with the auditor without management present

• Extent to which the audit committee probes issues raised by the auditor


43

Evaluation of Adequacy of the Two-Way Communications with the Audit Committee• If the auditor determines that the two-way

communications between the audit committee and the auditor have not been adequate and the situation cannot be resolved, the auditor should consider:

Communicating with the full board of directors

Modifying their opinion on the basis of a scope limitation

Withdrawing from the engagement

• This should serve as a final “wake-up call” for audit committees who do not have an adequate handle on risks or following-up on red-flags


44

PCAOB Proposed Auditing Standard:Communications with Audit CommitteesPCAOB Release No. 2010-001, March 29, 2010

• The Board anticipates that the standard will be effective, subject to approval by the SEC, for audits of fiscal years beginning on or after December 15, 2010

• Challenges:

Lack of independence since the evaluator (the external auditor) is hired by the one being evaluated (the audit committee)

Educating audit committee members


45

Other SEC Hot Buttons:Regulation FD (Fair Disclosure) Violations

• SEC Staff came out with guidance back in August of 2008 saying that blogs and other interactive websites are subject to the anti-fraud provisions of the federal securities laws, and companies cannot require investors to waive protections as a condition of using such interactive websites.

• The SEC has begun to send deficiency letters to registered investment advisers if they don’t have a social media policy in place. They are also asking for a broad range of data related to social media use, such as how often advisers use social media websites (Facebook, Twitter, LinkedIn, YouTube, Flickr, MySpace, Digg, Redditt) as well as any blogs used.

• Need to have a very clear, intelligent social media policy that either limits or forbids disclosure of non-public information through blogs and social media.IMA’s 92nd Annual Conference


46

Trends

• Regulatory reform moves into 2011 with one foot on the gas pedal and the other on the brake

Also

DELAYS!!IMA’s 92nd Annual Conference © 2011 Institute of Management Accountants. All rights reserved.

47

Delays Announced in 2011 (so far)• February: SEC announced that certain activities, such as the

creation and staffing of Office of Credit Ratings and the Office of Municipal Securities, would be delayed because of “budget uncertainty.”

• April 9: SEC pushed back several of its Dodd-Frank Act implementation deadlines. The delayed provisions were originally scheduled to be approved by July and are now scheduled by December

• April 14: Leaders of the FASB and IASB said they have pushed back their work on the handful of “priority” projects from a June 2011 target. The priority projects (leases, revenue recognition, and financial instruments) and the joint project on insurance contracts are now expected to be completed by the end of 2011

• April 21: SEC Delays XBRL Compliance for Foreign Private Issuers that Prepare Their Financial Statements in Accordance with IFRS


48

Will the SEC Delay the Biggie – IFRS???

• SEC has pledged to decide in 2011 as to whether, when, and how the current financial reporting system for U.S. public companies should be transitioned to a system incorporating IFRS

• At the 2010 AICPA National Conference on Current SEC and PCAOB Developments, Chairman Schapiro affirmed the 2011 decision, but said it also depends on the FASB’s and IASB’s progress on the convergence projects and the results of the SEC staff’s work on the detailed work plan. She also affirmed that the first date U.S. domestic issuers would report under IFRS would be no earlier than 2015


49

Trends: SEC, PCAOB, and Others

• Regulation

• Disclosures

• Focus on Risk

• Focus on Board & Audit Committee

• Enforcement

• IPOs


50

Trends: SEC, PCAOB, and Others

• Public appetite for regulation• Companies listed on major U.S. exchanges

From 8,823 in 1997 to 5,091 as of February Going private transactions Public company M&A transactions Delistings for being out of compliance


51

Mitigating Risks of Non-Compliance• Stay in the SEC’s best graces by adhering to their

rules and regulations. This includes taking disclosure control requirements (design and evaluation) seriously, as certified by CEO & CFO per Exhibit 31 in all periodic reports. Disclosure controls include:

Establish and enforce accountability on who, when, where, how SEC filings are prepared

Establish a training program to stay abreast of new rules & hot buttons

Implement a sub-certification process


52

Disclosure Controls - continued

• Incorporate a robust legal review process for key SEC disclosures

• Establish disclosure committee and conduct periodic meetings

• Utilize a checklist(s) to help ensure all required topics are covered

• Conclude on disclosure controls evaluations & formalize through a memo for audit trail purposes


53

“Be Prepared” !!! - Foster a Healthy Culture through Strong Disclosure

Controls

Questions?

The Author and Presenter of this concurrent session,

Ron Kral, can be contacted at [email protected]

608.204.0122


mailto:[email protected]

54

Speaker Bio Ron Kral, MBA, CPA,

CMA ([email protected])

Ron is the Managing Partner of Candela Solutions LLC, a public accounting firm with a national focus on governance, risk and compliance. He has been an external auditor responsible for signing audit opinions and a divisional financial executive for a multi-billion dollar NYSE firm. Currently he is an educator, advisor and internal auditor for boards of directors and management teams.Prior to forming Candela Solutions, he was a Principal Consultant with PricewaterhouseCoopers, leading performance auditing, internal controls and governance projects. Ron began his public accounting and consulting career with a California CPA firm as a Financial and Compliance Auditor, where he worked extensively with Ernst & Young.Ron is a nationally recognized speaker on governance, business ethics, internal controls, and SEC regulations. He helps companies understand the regulatory environment to devise cost-efficient responses to extract value, not just compliance. Ron believes that all business activities should be focused on creating and preserving shareholder value.Ron is a member of the AICPA, FEI, IIA and IMA. He was authored numerous professional articles and was a member of FEI’s National Task Force on the COSO Monitoring Guidance Project. He holds an MBA from Arizona State University and a BBA from the University of Wisconsin.


http://www.candelasolutions.com/

Documents

1 IMA’s 92 nd Annual Conference © 2011 Institute of Management Accountants. All rights reserved. SEC Update: Likely Impacts for Boards, Management Teams