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In the last several days, the SEC has engaged in a skirmish, and possibly an opening battle, against SPACs.  A recap follows.

The first shot was fired on March 31, when the Staff of the SEC’s Division of Corporation Finance and the Office of Chief Accountant issued separate public statements about a number of risks and challenges associated with taking private companies public via “deSPAC” transactions.

The CorpFin statement covered a lot of territory, pointing out the following pitfalls, among others, facing companies that go public via a deSPAC.  These pitfalls reflect that such companies are subject to rules governing shell companies that do not apply to companies going public through conventional IPOs.

  • Financial statements for the target must be filed with an 8-K report within four business days of the completion of the business combination.  The usual 71-day extension for such financial statements is not available.
  • The combined company will not be eligible to incorporate Exchange Act reports or proxy or information statements until three years after the completion of the business combination.
  • The combined company will not be eligible to use Form S-8 for the registration of securities issuable under compensation and benefit plans until at least 60 calendar days after the combined company has filed current Form 10 information. (This information is customarily included in a “Super 8-K” filed within four business days after closing of the deSPAC transaction.)
  • For three years following the completion of the deSPAC transaction, the company will be unable to use some streamlined procedures for offerings and other filings, such as using a free-writing prospectus.

The statement also reminds companies that public issuers are required to maintain accurate books and records as well as internal control on financial reporting – both areas that have been the basis for enforcement actions by the SEC.
Continue Reading Caveat Everybody — The SEC Takes Aim at SPACs

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While we have been busy in 2020 learning how to social distance, wear masks and do Zoom meetings, the SEC has spent the year turning out a relentless tsunami of new rules and amendments of old ones. Among the latter are extensive amendments to the financial disclosure obligations of a public company when it acquires or disposes of a business. Adopted in May 2020, these long-awaited amendments go into effect on January 1, 2021, so a summary seems timely.

Given the extent and complexity of these amendments, we will summarize them in installments. This first installment considers the changes to the periods to be presented in the financial statements, the amendments to the Investment Test and the Income Test in the definition of a “significant subsidiary,” and the codification of the staff practice of permitting abbreviated financial statements for acquisitions of components of an entity. In reading this and future summaries, bear in mind that the new rules are complex and need to be reviewed carefully against the detailed terms of an acquisition or disposition.
Continue Reading The SEC Fixes those Pesky M&A Financial Disclosure Requirements

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I don’t know very much about the federal budget process, but I do know that any budget proposed by the White House – regardless of its occupant – isn’t worth spending time on, and that by the time the budget is passed, it often looks

As securities lawyers know, disclosure is generally regarded as the best disinfectant.  However, in a recent enforcement action, the SEC determined that disclosure is not always enough.  Specifically, when it comes to internal controls over financial reporting, or ICFR, companies need to actually fix the problems they disclose.

In the action, the SEC cited

Lest you think that the SEC’s focus on the use of non-GAAP financial metrics is so, well, 2018, think again.  On December 26, the SEC issued a cease-and-desist order against a company based entirely on the company’s use of non-GAAP metrics without giving “equal or greater prominence [to] the most directly comparable financial measure or measures calculated and presented in accordance with GAAP…”, as required by Item 10(e)(1)(i)(A) of Regulation S-K.

According to the SEC order, the company in question – ADT, the security company based in Boca Raton, Florida – issued earnings releases for fiscal 2017 and the first quarter of fiscal 2018 that prominently included such non-GAAP metrics as adjusted EBITDA, adjusted net income, and free cash flow before special items, without giving equal or greater prominence to the comparable GAAP data.  For example, the order states:
Continue Reading Ho, Ho, Uh-Oh: The SEC continues to focus on non-GAAP disclosures

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Now that “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (the official name of the 2017 tax reform act – fitting for a “simplification” of the tax code!) has passed, issuers are faced with reviewing the impact of the tax reform act on its balance sheet, specifically deferred tax assets and deferred tax liabilities.

For those of us who have ignored those lines on the balance sheet, here is a quick primer: US GAAP and the US tax code have different requirements as to when to recognize income and expenses. These timing differences result in either deferred tax assets or deferred tax liabilities. In other words, if the US tax code requires recognition of income this year, but GAAP does not recognize the income yet, an issuer will need to pay the tax on the income now (the government doesn’t like to wait for its money). That’s an asset from a GAAP perspective – the issuer essentially “prepaid” income taxes that weren’t yet due as far as GAAP is concerned. From a GAAP perspective, that deferred tax asset will be used to offset GAAP tax expense in future years. The opposite is true with respect to deferred tax liabilities.

When the corporate tax rate changes (in this case, from a maximum of 35% to a maximum of 21%) the deferred tax assets aren’t as valuable anymore because the issuer won’t be subject to as much tax as it originally thought. Therefore, the tax asset needs to be written down to some lower value. That write down hits the bottom line and will have a significant adverse impact on the issuer’s quarterly results. Again, for those issuers “lucky” enough to have had significant deferred tax liabilities, those issuers will have significant gains in the quarter caused by, in essence (by lowering the tax rate), the US government partially forgiving the payment of those accrued tax obligations.

Issuers over the past week have begun to provide guidance as to what they expect the effect of the tax cut to be for their deferred tax assets and deferred tax liabilities.  However, there is no black and white rule requiring disclosure in this case.  While Item 2.06 (Material Impairments) of Form 8-K may initially have been of some concern for those issuers who need to write off tax assets, Corp Fin put those concerns to rest when issuing a new CD&I last week (Question 110.02). Consequently, it comes down to anti-fraud concerns as to when and what to disclose. 
Continue Reading Tax cut implications – what and when to disclose

Some of you may remember Christopher Cox, who served as SEC Chair from 2005 to early 2009, when he was succeeded by Mary Schapiro.  His name doesn’t come up often, perhaps because his legacy was a weakened Commission tarnished by, among other things, the financial crisis and the Madoff scandal.

While Chairman Cox may not have been responsible for either of those debacles, he did leave another unpleasant legacy – XBRL.  He was among the biggest cheerleaders for XBRL, claiming that it would enable investors to compare companies within and across industries and would perform various other miracles.  Suffice it to say it hasn’t done that.  Aside from the fact that it’s time-consuming, it has failed to provide the benefits of comparability.  As a client recently said,

“[E]ven if two companies use the same taxonomy/tagging for Cost of Sales, they probably are not consistent in the underlying details that go into Cost of Sales.  One company might classify certain components as G&A instead.  There are many other examples.  Consistency is very important for one company’s reporting from period to period, however comparisons of competitors’ financials will always be approximations at best.”Continue Reading RIP XBRL?

PCAOB creates yet another dumpster fire  (Photo by Toms River FD)
PCAOB creates yet another dumpster fire
(Photo by Toms River FD)

Earlier this month, after seven years of threats, the PCAOB adopted rules to drastically change the standard auditor’s report. In adopting the rules, the PCAOB noted that the standard auditor’s report had largely remained unchanged since the 1940s. I believe there was good reason for this: the current auditor’s report works well (or at least well enough). It is simple and, therefore, easy to interpret. Either a company receives an unqualified opinion or it doesn’t. The current report is generally referred to as a pass/fail model. But, the simple and straightforward approach is about to change.

Enter the CAMs

The PCAOB has introduced a new acronym for us to learn, CAM, which stands for Critical Audit Matter. Under the new rules, a CAM is any matter communicated or required to be communicated to the audit committee that: (i) relates to material accounts or disclosures that are material to the financial statements and (ii) involves especially challenging, subjective, or complex auditor judgment. Each and every CAM, as determined by an issuer’s auditor, will then be identified and described in the audit report and the auditor will explain how the CAMs were addressed in the audit. Simple enough, right? Don’t worry, if you are confused – the rules contain a flow chart!

The whole idea behind the CAMs concept is that it is designed to reduce the information asymmetry that exists between investors and auditors. The PCAOB is concerned that investors are unable to adequately assess the risk that underlies the estimates and judgments made by management in preparing the financial statements. That’s probably a fair assessment, but changing the auditor’s report won’t address information asymmetry. And here’s why:

First, critical audit matters are already identified in the MD&A and the financial statements. The PCAOB claims that the auditor should not be limited to discussing the estimates that management discloses. While that may be a good point, most sophisticated users of financial statements should be able to identify the significant estimates an issuer would make. Generally, these estimates are consistent from company to company based on their industry. Is it a revelation that a commercial bank’s most significant estimate is its allowance for loan losses? Or that the valuation of inventory would be important to an issuer with a large inventory balance (especially if the inventory can quickly become obsolete)?

Second, the PCAOB notes that if there aren’t any identified CAMs then the auditor will need to state that fact. What’s the likelihood that any of the larger accounting firms will go on record to state that there was very little judgment used in compiling a set of financial statements? I think the likelihood is next to zero. Also, what is the likelihood that each auditor will craft a custom disclosure each year
Continue Reading The CAMs are coming and other enlightened enhancements courtesy of the PCAOB

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©killaee

Over the years, the PCAOB has developed a reputation for pursuing zombie proposals – proposals that appear to be dead due to widespread opposition and even congressional action.  Remember mandatory auditor rotation?  It practically took a stake through the heart to kill that one off, and I’m informed that even after it was presumed to be long gone some PCAOB spokespersons were telling European regulators that it might yet be adopted.

Well, here we go again.  The latest zombie proposal (OK, reproposal) would modify the standard audit report in a number of respects, the most significant of which would be to require disclosure of “critical audit matters”.  The headline of the PCAOB’s announcement of the reproposal says that it would “enhance” the auditor’s report; not clarify, just “enhance”.   And, as is customary whenever the PCAOB proposes to change the fundamental nature of the audit report, the proposal starts out by sayng that’s not the intention at all: “The reproposal would retain the pass/fail model of the existing auditor’s report,” it says.  It seems to me to lead to the opposite result – the introduction of critical audit matter (“CAM”) disclosure could easily lead to qualitative audit reports; one CAM would be viewed as a “high pass”, two would be ranked as a medium pass, and so on, possibly even resulting in numerical “grades” based upon the number of CAMs in the audit report.  And let’s not fool ourselves into thinking that any audit firm would ever issue a clean – i.e., CAM-free – opinion.  I just can’t envision that happening, ever.Continue Reading Another zombie from the PCAOB

ASU 2016-09 - Share-Based Accounting
Photo by David Fulmer

Over the past couple of months, the FASB has been busy. I wanted to point out one recent change and my thoughts on its impact.

FASB has “simplified” share-based compensation accounting. I will always have a special place in my heart for old FAS123 since it was on my CPA exam a couple of decades ago.  Nevertheless, much has changed since then (APB No. 25 anyone?), including most recently:

  • No more APIC pools. Currently, tax benefits in excess of compensation cost are recorded in equity (specifically, Additional Paid In Capital or APIC). The accumulation of excess benefits has been known as an APIC pool. Tax deficiencies decrease the APIC pool. Under the new accounting rules, excess benefits and deficiencies are recognized in the period in which they occur.

My Take – Expect more income tax expense volatility from period to period. If the changes impact tax expense significantly, we could see more non-GAAP financial measures develop. Just be careful of the renewed focus on non-GAAP financial measures from the SEC.

  • No longer need to estimate forfeitures. GAAP currently requires you to estimate the number of awards that will be forfeited to calculate a more accurate amount of compensation cost each period. Under the new rules, you can continue to estimate or you can just reverse the compensation previously expensed when the forfeiture occurs. If you choose the new route, then you will have to hit retained earnings for the cumulative-effect adjustment incurred as a result of the change as of the beginning of the year the change is applied.

My Take – Again, there could be potentially more volatility if you elect to apply the new “actual” forfeiture approach.   A good example of volatility would be if a company had a significant layoff of employees. The increase in forfeitures during the layoff period would significantly
Continue Reading Impact of accounting literature: Time to get out of the pool and other changes