From the SEC

Leadership

SEC Chair

On May 4, 2017, Jay Clayton was sworn in as the new SEC chair. Clayton comes from the law firm Sullivan & Cromwell LLP, where he was a partner advising clients on capital raising and trading matters in the United States and abroad.

Division of Corporation Finance (Corp Fin) Director

On May 9, 2017, Clayton announced that William H. Hinman will be the new director of Corp Fin. Hinman recently retired as a partner at Simpson Thacher & Bartlett LLP, where he advised public and private companies, including issuers and underwriters, on capital-raising transactions and acquisitions.

Speeches

Revenue Standard Disclosures, COSO Framework, Operating Metrics, and Auditor Independence

In his remarks at the 2017 Baruch College Financial Reporting Conference on May 4, 2017, SEC Chief Accountant Wesley R. Bricker discussed implementation of the major accounting standards, internal control, operating metrics, and auditor independence.

He urged preparers not to delay implementation efforts for the new disclosures required under the revenue recognition standard, and he cautioned preparers that the disclosures may be among the most challenging tasks in adopting the standard.

On internal control over financial reporting (ICFR), he asked those who use the Committee of Sponsoring Organizations of the Treadway Commission (COSO) internal control framework to adopt the updated 2013 “Internal Control – Integrated Framework” issued by COSO if they have not already done so. He also requested that COSO monitor the evolution of business and operating environments to determine whether further updates are necessary.

He mentioned not-often-discussed operating metrics and forecasts and stated that lessons learned on the presentation of non-GAAP measures could be applied to reporting of other types of financial information. He offers the following recommendations:

• Understand how the financial information is defined.
• Ensure that robust disclosure controls and procedures are in place.
• Consider insight from outside the finance and investor relations functions of the company.

Finally, on the topic of auditor independence, he mentioned a recent consultation about an auditor proposing (prior to dismissal) on prohibited nonaudit services to be performed after the end of the audit and professional engagement period, and he noted the SEC staff’s view that this potentially could impair an auditor’s independence. In addition, he noted that while the firm is still the auditor, the proposal could adversely affect the auditor’s professional skepticism.

Non-GAAP Measures and Disclosure of Recently Issued Accounting Standards

In his remarks before the 2017 Baruch College Financial Reporting Conference on May 4, 2017, Corp Fin Chief Accountant Mark Kronforst focused primarily on non-GAAP disclosures and the disclosure of recently issued accounting standards.

He opened by noting recent improvements in non-GAAP disclosures under Regulation G as issuers have re-evaluated their non-GAAP disclosures in response to the updated Compliance & Disclosure Interpretations released in May 2016. After observing an implementation period for the new guidance, Corp Fin sent registrants comment letters related to non-GAAP disclosures, primarily focused on the following areas:

• Non-normal cash expenses – A non-GAAP adjustment for non-normal cash expenses should not include recurring cash expenses, such as advertising and marketing. That is, recurring cash expenses should be considered “normal” cash expenses.
• Cherry-picking – Non-GAAP disclosures that adjust for unusual or one-time charges also should be adjusted for unusual or one-time gains.
• Accelerating revenue – The acceleration of revenue should be included in non-GAAP disclosures only if new or changing accounting standards would cause a change in revenue recognition.
• Per share liquidity measures – Cash flow per share disclosures are prohibited.
• Income taxes – If the non-GAAP disclosures present an alternative calculation of net income, the non-GAAP disclosures should include the income tax effects on that amount.

Kronforst also noted that if a prospective non-GAAP measure is provided in the disclosures, then a GAAP measure and a reconciliation between the two measures should be presented. He further noted, however, that Regulation G includes an exception that allows issuers to provide only prospective non-GAAP measures if the reconciliation and corresponding prospective GAAP measure would require “unreasonable efforts.” Kronforst stated Corp Fin has not issued comment letters challenging issuers who have used the unreasonable efforts exception and has no plan to focus on it in the future.

Kronforst noted that Regulation G requires issuers to present GAAP measures with at least equal prominence to non-GAAP measures. The SEC’s position is that equal prominence requires that GAAP measures be disclosed before non-GAAP measures, because presenting non-GAAP measures first inherently gives less prominence to the GAAP measures.

Finally, he noted that Corp Fin has begun issuing comments on the topic of Staff Accounting Bulletin (SAB) 74 requirements pertaining to the disclosure of recently issued accounting standards. SAB 74 disclosures should include not only cumulative effects of adoption of the standards but also changes to disclosures and new material information that will be provided in the financial statements as a result of the adoption of the standard.

Non-GAAP Measures

At the 36th annual SEC and Financial Reporting Institute Conference on June 8, 2017, Mark Kronforst revisited the status of the non-GAAP disclosure requirements and their implementation. In his remarks while participating on a panel, he noted that implementation of Corp Fin’s May 2016 Compliance & Disclosure Interpretations are considered to be a success.

Kronforst noted that the SEC’s focus in reviewing non-GAAP measures remains on verifying that non-GAAP measures presented by companies are not materially misleading to the users of the financial statements. He struck an optimistic note, observing that companies have made substantial progress in addressing problems involving non-GAAP measures but should expect continued scrutiny on the following areas:

• Tailored accounting principles, with the main focus on revenues
• Financial statement presentation that consolidates equity investees and controlled entities on a theory of proportionate consolidation, which is a particular problem in the REIT (real estate investment trust) industry
• Backing out normal, recurring, cash operating expenses, such as marketing and litigation expenses 
• Cherry-picking by disclosing one-time gains but not losses in non-GAAP measures
• Prominence – noting that the GAAP number always should come first, including in the earnings release and the GAAP reconciliation
• Per share liquidity measures, which are prohibited
• Non-GAAP forward-looking earnings per share (EPS) guidance
• Calculation and presentation of income tax effects – so that if the non-GAAP disclosures present an alternative calculation of net income, the non-GAAP disclosures should include the income tax effects on that amount

Kronforst was asked why stock compensation is still allowed as a non-GAAP adjustment. He noted that the stock compensation expenses were not a focus of the project, and the staff did not find stock compensation adjustments to be misleading under existing rules.

Another question dealt with where there is still room for improvement for some companies’ non-GAAP disclosures. Kronforst emphasized the importance of establishing controls related to decisions on non-GAAP measures and adjustments, including disclosure controls and procedures. In addition, he stressed the importance of the audit committee’s role in being more vigilant in overseeing management’s use of non-GAAP measures to avoid bias and ensure compliance with the requirements.

Last, a question was posed in relation to an auditor’s role and involvement in the company’s implementation of and compliance with non-GAAP disclosure requirements. According to Kronforst, although non-GAAP disclosures are outside of the scope of the audit, auditors should read and consider the non-GAAP disclosures to verify that certain information is consistent with the audited financial statements. Auditors should sit down with the audit committee, internal audit, and management to talk about controls, comparability, transparency, and consistency of applying the non-GAAP measures.

Revenue Recognition

Sylvia E. Alicea, professional accounting fellow in the SEC’s Office of the Chief Accountant, delivered the keynote address at the Bloomberg BNA Conference on Revenue Recognition on May 8, 2017. She covered matters related to implementation of the new revenue recognition standard, including:

• Observations from recent consultations about application of the standard
• Reminders on transition disclosures
• Responsibilities of management and audit committees related to ICFR when implementing new GAAP standards

Alicea’s observations included the need to identify and evaluate all relevant contractual terms when identifying the contract, because the terms may affect accounting conclusions. She also noted that identifying “performance obligations” is a new concept under the revenue standard. Highlighting the new disclosure requirements, she stated, “[t]he pertinent facts and related reasonable judgments related to a registrant’s contracts with customers, including the significant judgments made in applying the principles of the new revenue standard, should be disclosed to better inform investors’ decisions.”

Regarding transition disclosures, Alicea reminded preparers of the SAB 74 disclosure guidance. The design process for those controls should contemplate the nature and objective of the transition disclosures as well as the status of the company’s implementation efforts. She emphasized that the new disclosures might be material even if the dollar impact to the balance sheet or income statement is not material. Disclosure on the impact of the new standard should reflect consideration of recognition, measurement, presentation, and disclosure. She clarified that the SAB 74 reference to financial statements also covers the notes to the financial statements.

Pending Audit Standard, New Accounting Standards, and Auditor Independence

On June 8, 2017, SEC Chief Accountant Wesley R. Bricker addressed the 36th annual SEC and Financial Reporting Institute Conference and covered the following topics:

• The PCAOB’s new auditing standard on the auditor’s report, which the SEC is expected to make available for public comment before voting
• The importance of oversight and governance of international audit standards in delivering high-quality audits internationally
• The new accounting standard on revenue recognition, including involvement by the audit committee and auditor during implementation, and reminders of the importance of the new required disclosures and transition disclosures as described in SAB 74
• The new accounting standards on leases, classification and measurement of financial instruments, and credit losses, including an emphasis on the scoping exercise for each of those standards and a recommendation to perform implementation activities for these major standards concurrently instead of doing it sequentially
• The importance of ICFR, including in the implementation periods for the new major accounting standards
• Auditor independence, specifically in the context of an audit committee selecting a successor auditor, including consideration of whether the successor auditor would be independent under SEC rules if the successor auditor were engaged to audit prior-period financial statements (for example, in the event of a restatement) or whether the predecessor auditor’s independence would be impaired by relationships entered into after the end of the engagement period

Confidential Draft Registration Statements for Initial Public Offerings

In an announcement on June 29, 2017, the SEC said that beginning on July 10, 2017, Corp Fin will allow all companies to submit draft registration statements for initial public offerings (IPOs) for nonpublic (or confidential) review. Certain foreign private issuers and emerging growth companies already enjoy this accommodation. A company will be permitted to submit registration statements to the SEC in order to start the SEC staff’s review of an IPO filing before the company announces to the public that it is pursuing an IPO.