Photo by Jan Kaláb

Step away from the phone!  That’s the message Elon Musk, the now former Chairman of Tesla and habitual Twitter user, should have heeded in August before he sent one of his latest ill-advised tweets.  Unfortunately, Musk let his critics (this time the short sellers of Tesla’s stock) get the better of him, and now Tesla and Musk are paying a high price for what amounts to an off the cuff remark.

The background, as you may recall, is that back in August, Musk tweeted that he was contemplating taking Tesla private at $420 per share and that he had “funding secured.”  Of course, as it was later discovered the $420 per share price was only loosely based on a financial model or expected financial performance of Tesla.  Rather, the SEC claims the price had more to do with impressing his girlfriend.  And the “funding secured” part had very little basis in reality either.

As a general matter, I would recommend against launching a going private transaction via tweet.  The SEC seems to agree.  On September 29, 2018, Musk and Tesla quickly settled an SEC lawsuit by Musk agreeing to step down as Chairman of Tesla for at least three years, each of Musk and Tesla paying a $20 million fine (to be distributed to harmed stockholders), Tesla agreeing to add two new independent directors to its Board, and Tesla agreeing to put in place new controls to review all social media communications of Tesla’s senior management, including company pre-approval of all Musk social media postings that may contain material nonpublic information.  The penalty is fairly harsh, but it is actually more mild than was originally intended – the SEC’ s lawsuit sought a bar from Musk serving as a director or an officer of a public company.

Given that Musk and Tesla settled the lawsuit two days after it was filed, Musk and Tesla must have believed that the SEC would not go away quietly or quickly.  The SEC clearly used a lawsuit against an outspoken
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Photo by Allen

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. 
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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
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This posting is a reprint of an article, co-authored by Bob Lamm and David Scileppi, that appeared in the Daily Business Review on July 15, 2016.    

Recent months have been difficult for the initial public offering market. In fact, year-to-date, IPOs are down nearly 60 percent compared to last year. One of the bright spots in this IPO down market has been Sensus Healthcare Inc., a Boca Raton-based medical device company.

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We are proud to have worked with Sensus Healthcare on its IPO, which priced on June 2; Sensus is now listed on NASDAQ under the SRTSU symbol.

Though we’ve worked on numerous offerings over the course of our careers, the Sensus transaction reminded us of some key things that companies should consider as they proceed toward an IPO.
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Photo by Chad Cooper
Photo by Chad Cooper

Good, but not surprising, news for issuers considering a Regulation A+ offering. Back in May 2015, Massachusetts and Montana sued the SEC in an attempt to invalidate the Regulation A+ rules.  Montana had attempted to obtain an injunction to prevent the Regulation A+ rules from going into

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
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Pay ratio disclosures
Photo by Brian Talbot

After much foot dragging, I have finished reading the adopting release for the new pay ratio disclosure rules.  Yes, the release is long (300 pages or so), but adopting releases are always long.  The real reason why it took so long is that the whole concept of pay ratio disclosure just seems silly to me (and apparently to Bob Lamm as well) so I just hoped it would go away.

I am not against finding ways to strengthen the middle class.  Just like I am not against ending the sale of certain minerals in Central Africa that end up funding deadly conflict.  The problem I have is that public companies should not have to bear the complete burden of fixing social ills.  Less than 1% of the 27 million companies in the United States are publicly traded.  And there are plenty of private companies that are larger than most publicly traded companies.  Thus, while we may not agree whether the social goals are worth achieving, I think we can all agree that there are better ways to achieve them than selective enforcement (particularly since the SEC itself has said that the pay ratio will not be comparable from one company to another).  The Securities Edge  has been criticizing the social disclosure movement for some time, but we haven’t yet seemed to have stopped Congress from continuing to go down that path.

So, unless Congress acts to reverse its mandate for public companies to disclose their pay ratios before 2018 (the first year of required disclosure), I suppose we should all start learning how to comply.  Leading practices for calculating the ratio and providing narrative disclosure will develop over the next couple of years, but I have summarized the important parts of the rules in this post:

What is the required disclosure?

Registrants must disclose:

  • The median of the annual total compensation of all employees of the registrant (excluding the CEO)
  • The annual total compensation of the CEO; and
  • The ratio of the median to the CEO’s compensation.

The ratio needs to be expressed as X:1 or X to 1 where “X” represents the CEO’s total compensation and “1” represents the median employee’s salary.  The ratio can also be expressed in narrative form such as: “The CEO’s annual total compensation is X times the median employee’s annual total compensation.”  You can’t
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Reg A+ is now effective!
Photo by Lisandro M. Enrique © 2015 All rights reserved

Today is June 19th.  It is an exciting day for companies that need to raise capital because Reg A+ finally goes into effect.

As a reminder, Reg A+ is a nickname for SEC Regulation A, as amended by the SEC.  Reg