SEC Trends and Developments May 2010

Dialogue from the Board Room

The editors of EisnerAmper’s SEC Trends & Developments recently had the opportunity to sit down with Louis Lipschitz, a director and audit committee member of Children’s Place Retail Stores, Majesco Entertainment, New York & Co., and Forward Industries to get his perspective on a number of matters. To see what he had to say, read on.  

Q. What impact does the current economy have on your responsibilities and duties?

LL: I think it requires us to have a little more focus and to make sure the companies we serve have adequate liquidity to withstand the negative impact the economy might have. Regardless of the economy, we should always be focused on the liquidity of the company. It also requires more focus in making sure that management is taking advantage of opportunities that could help strengthen the business, shore up weaknesses or respond to changes in consumer trends, etc. There are pros and cons on taking advantage of these opportunities, all of which should be considered from a business viewpoint.

From your perspective what are or what should be the top concerns for the Company or the Audit Committee now?  

Hopefully we can get back to the basics – continue challenging whether controls are adequate and are they working properly, are disclosures giving shareholders what they need and are they transparent, and are the companies addressing their strategic goals which is what they should be focusing on, which is no different than what we should have been focusing on all along.

What are your thoughts on SOX for small and non-accelerated filers? Do you think that the costs for compliance with the SOX requirements are indispensible?  

I think the basic premise of SOX is what all companies should have been doing all along, and most were. I think that small non-accelerated filers can achieve most of the benefits without incurring the cost of compliance which is the window dressing, not the substance of what you should do. All companies should have good controls and should be focused on those controls. I don’t think you have to go through all the requirements that SOX put into place in order to achieve that.

The SEC has recently adopted amendments to its proxy rules about risks posed by the Company’s compensation structure, the Company’s risk management processes generally, and the role of the Board in risk oversight. What steps have you taken with regard to these new rules?  

I think most successful well-run businesses have always factored risk into their daily operations so the SEC isn’t raising any new issues. The steps taken have to be better documented across the risk framework because the Board has to make sure that they are fulfilling their oversight responsibilities and thus you need better documentation than what may have existed in the past. I don’t think it’s anything new and I think you have to ask management the right questions. My concern is that with all this emphasis on risk, we can end up with overregulation in this area. The “one size fits all” philosophy does not work effectively. Companies have got to be wary of regulatory requirements driving business decisions because the biggest risk in my opinion is that companies become so risk averse that they stop taking risks. Companies cannot be successful unless they are willing to take risks but, of course, if they are going to take risks they have to be well thought-out. I think each company has to do what’s good for its own self in its own situation and we can’t over regulate.

 What are your perspectives with respect to financial fraud? In this environment, what are some of the areas that the Board or the Audit Committee should focus on to steer clear of financial fraud?  

I think you have to go back and say what’s the best way to prevent financial fraud and in my mind that’s to make sure that the tone at the top is sending the right message and that message is being reiterated at all levels within an organization. That coupled with good internal controls and good disclosure controls should minimize the probability of fraud and therefore the Audit Committee should focus on tone, attitude controls and that way I think you’ll see a minimization of financial fraud. You are never going to eliminate fraud but you can definitely minimize it.

 What are your perspectives on the convergence between U.S. GAAP and IFRS? Will companies be able to recap any benefits during the initial transition and adoption phases?  

My perspective is that convergence is coming whether we like it or not and the sooner we accept that as a fact the better off we are. I think a lot of people are still in denial. There will be a high cost of transition and we will probably be able to reap benefits from it. Some of the benefits will be from systems upgrade because you’re going to need to change systems in order to accommodate IFRS requirements and if you plan for that properly, the system upgrades can serve multiple purposes. In the long run when the pain is behind us, I think having a global system for reporting makes a lot of sense because the world is becoming smaller and smaller, and most companies are impacted by global operations in one form or another.

Privacy and Data Security: Minimizing Risk  

Effective data protection programs must be designed and implemented as part of the business process. Many companies have struggled with this strategic goal. We will outline the first steps in building your privacy compliance program. Management is ultimately responsible for the privacy compliance program implementation and operating effectiveness.  

As an executive, at some point you’ve considered the risks of an inefficient Information Security Safeguard Program and its ability (or inability) to protect personally identifiable information (PII) of employees, contractors, clients and stakeholders. And you know preventive measures are far less costly, both financially and operationally, than re-engineering systems after an incident or significant breach has occurred. So what reasonable measures can be taken to minimize risk?

Review the Privacy Policies Annually, including the legal requirements. Practices evolve rapidly, and regulations follow. Enterprise managers need to make sure they’re aware of the latest developments. As an example, think how much communication has changed recently. Just two or three years ago, the primary modes of sharing information were email and telephone. Now, the majority of information to be disseminated first sees the light of day via internet postings, including through social networking sites like Twitter and Facebook. In fact, a policy handbook including code of conduct specifically covering social media should be part of every company’s compliance toolkit.

Identify and Categorize the Data Assets. Data management starts with the inventory of assets. When collecting data, managers should “tag” data to be able to identify, track, and categorize where sensitive PII is stored to effectively protect and utilize the information as well as perform reporting. Tagging also helps managers create real-time status reports so they can see how knowledge is being shared.

Establish a Compliance Monitoring Program over Privacy Policies. Training programs and employee manuals are valuable first steps, but are they being followed? How are they enforced? Surveys and annual reviews are good practices. It is critical that employees understand their responsibilities surrounding PII. Policy adherence should be made part of the on-boarding process of new hires.

Be Aware of Information Requests, Internally and Externally. Each request necessitates the retrieval of data from a system. Consider who has access during that process. Examine where your PII is gathered, retained, maintained, and shared. Maintain an inventory list of internet sites operated by your organization, as well as all shared servers. Examine what the organization is doing to protect itself from risks that range from exchange ports and thumb drives to handheld PDAs and laptop computers.

Examine Physical Aspects of PII Security. Inspect the sites where information is held, both in-house and at outside storage facilities. Build protocols to protect both the information and storage tools. Are personnel files physically secure? Who has access and how were they hired and trained? How long is the material retained for and is there a policy regarding document destruction? The answer to many of these questions will depend on specific state and other regulations that your company is responsible for knowing and following.

Privacy compliance and data protection programs encompasses the processes that an organization employs to protect and secure its systems, media, and facilities for processing and maintaining vital information. The processes to safeguard confidential data are the primary defenses of an Information Security Safeguard Program. An organization can be adversely affected if information becomes known to unauthorized parties, is altered, or is not available when needed. Executives need to assess the effectiveness s of their Information Security Safeguard Program, in particular the financial, operational, and reputational risks to their organizations. Now more than ever, the ability to proactively manage, protect and share PII, intellectual property, and other sensitive data in a cost-effective manner – both within an organization and with strategic partners, trusted advisors, clientele, and other parties – is crucial.

 A new exposure draft on the concept of reporting entities, including how they control other entities, “Conceptual Framework for Financial Reporting: The Reporting Entity,” is the result of a joint effort by the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”). This is part of a project to develop a common conceptual framework for developing future accounting standards. A discussion paper on this topic was issued in May 2008 and it received comments broadly supporting the preliminary views on the subject. This new exposure draft describes what a reporting entity is, and when an entity controls another entity. It also discusses the considerations on presenting consolidated financial statements, parent-only financial statements and combined statements.  

In response to the May 6 stock market “Flash Crash,” when the Dow Jones Industrial Average fell nearly 1,000 points in a few minutes before recovering much of the loss, the SEC has proposed new rules that would reduce volatility in certain individual stocks. Under the proposed rules, trading would halt for companies in the S&P 500 if the stock price changed by more than 10%, either up or down, in a five-minute period. This plan is set to begin a six-month pilot period in June. SEC Chair Mary Schapiro said in a statement “We continue to believe that the market disruption of May 6 was exacerbated by disparate trading rules and conventions across the exchanges. As such, I believe it is important that all the exchanges quickly reached consensus on a set of uniform circuit breakers that would be triggered when needed.” Under the proposal, exchanges that list the stock would be responsible for restarting trading after the five- minute pause.  


 It’s Not Political; It’s Required

David A. Cace

I often receive phone calls from clients, attorneys and other friends of the firm asking me technical accounting questions, or seeking clarification regarding current events that have some financial reporting significance. I have never received as many of these types of phone calls, however, as I have regarding the reported charges to earnings being taken by many corporations as a result of the recent passing of the Patient Protection and Affordable Care Act (the “Act”). As a result, I thought I would explain the issues with as little accountant speak as possible.

Historical Background  

In 2003, employers were offered a tax incentive to provide prescription drug coverage to their Medicare Part D eligible retirees in the form of a federal tax-free subsidy, referred to as the Retiree Drug Subsidy (“RDS”). This enabled corporations to claim a tax deduction for 100% of the cost of providing such coverage without regard to the federal subsidy. Under the Act, the RDS will continue, but it will no longer be tax free, thus reducing the tax deduction for prescription drug benefits to 72% for future tax years (assuming the maximum 28% benefit).

Corporate Announcements  

No sooner was the Act signed into law by the President did corporations announce significant charges against earnings, some in the billions of dollars. Supporters of the Act have denounced such charges as overreactions to the passing of the Act. The corporations affected have denied that such charges are politically motivated.

Accounting Standards Applicable to Tax Law Changes 

If corporations didn’t take this charge, their financial statements would not be in conformity with GAAP. The technical accounting literature is clear and straightforward and can be found in Statement of Financial Accounting Standards No. 109 (¶27), Accounting for Income Taxes, now codified under Topic 740, Income Taxes, which states: Deferred tax liabilities and assets shall be adjusted for the effect of a change in tax laws or rates. The effect shall be included in income from continuing operations for the period that includes the enactment date. (emphasis added) The confusing part is applying this simple accounting standard to the complex area of postretirement benefits.

Accounting Standards Applicable to Postretirement Benefits
Historically corporations did not have to record the full liability related to their defined benefit pension plans until 1987, and it wasn’t until 1993 that corporations had to record the full liability for other postretirement benefits provided to retirees, primarily related to health care benefits.

These types of employee postretirement benefits will be paid many years into the future and thus are actuarially determined using estimates that are by their long-term nature subject to assumptions that are difficult to predict and fluctuate from year to year. Nevertheless, if an employer is obligated to pay these benefits, an estimated liability for the present value of these future benefits must be recorded today.

While under GAAP a liability for postretirement benefits, and the related expense, must be recorded today, a corporation doesn’t receive a tax deduction (i.e., tax benefit) until the postretirement benefit is actually paid. This difference in the timing of when the expense/liability is recorded in financial statements and when they are reflected in the tax return is referred to as a deductible temporary difference under GAAP requiring the creation of a deferred tax asset for the future tax benefit of the deduction.

The new law change reduces the future tax deductions for postretirement prescription drug benefits to the extent of the elimination of the tax-free nature of the RDS thereby resulting in an immediate reduction in the related deferred tax asset and corresponding deferred tax expense charge to earnings. This change affects deferred tax assets and expenses only and does not affect the pre-tax expense or corresponding liability for postretirement prescription drug benefits.

Concluding Comments  

These are non-cash charges to earnings – one can estimate the effect on cash flow based on the existing 35% corporate tax rate applied to the elimination of the tax-free nature of the subsidy. Any changes in future tax rates will also have to be recorded in the period enacted – if tax rates increase, existing deferred tax assets and liabilities will also increase, with a resultant impact on earnings.

David Cace is a partner in EisnerAmper’s Litigation Consulting & Forensic Accounting Services Group.

As a result of SEC reviews of Form 10-Ks and disclosures related to the Lehman investigation, the Division of Corporation Finance has sent letters to certain public companies requesting information about repurchase agreements, securities lending transactions, and other transactions involving the transfer of financial assets with a repurchase obligation. The information requested includes the amount of repurchase agreements or other securities lending transactions accounted for as sales at each quarterly balance sheet date for each of the past three years, a detailed analysis supporting the use of sales accounting treatment for those repurchase agreements or other securities lending transactions, the business reasons for structuring the repurchase agreements as sales transactions as opposed to collateralized financings, an explanation of any change in the original accounting for repurchase agreements within the past three years and a description of the effect of the change on the financial statements. In addition the SEC has asked that if repurchase agreements or securities lending transactions were not disclosed in the Company’s MD&A, why such disclosure was not made.  

 Latest Comments from the Commission  

“Latest Comments from the Commission” intends to highlight some of the more frequently appearing quotes from recent SEC comment letters. For a complete listing of SEC comment letters and registrants’ responses, please visit the commission’s website at 

 Liquidity and Capital Resources 

Please tell us what consideration you gave to outlining the material covenants appearing in your credit agreement and describing your state of compliance with those covenants.

Please expand this section to discuss known material trends and uncertainties that will have, or are reasonably likely to have, a material impact on your revenues or income or results in your liquidity decreasing or increasing in any material way. For example, we note your discussion regarding your decrease in cash provided by operating activities primarily due to a decrease in net income. Discuss whether you expect this trend to continue and how it may impact your plans to expand, your available liquidity, or any other factors. Please provide similar additional analysis concerning the quality and variability of your earnings and cash flows so that investors can ascertain the likelihood or the extent past performance is indicative of future performance. Please discuss whether you expect levels to remain at this level or to increase or decrease. Also, you should consider discussing the impact of any changes on your earnings. Further, please discuss in reasonable detail: 

  •  Economic or industry-wide factors relevant to your company, 
  • Material opportunities, challenges, and 
  • Risk in the short and long term and the actions you are taking to address them.

See Item 303 of Regulation S-K and SEC Release No. 33-8350.

Critical accounting policies and estimates Your discussion should supplement, not duplicate, the accounting policies disclosed in the notes to the financial statements and provide greater insight into the quality and variability of information regarding financial condition and operating performance. As such, please:

  • Provide an analysis of the uncertainties involved in applying critical accounting principles or the variability that is reasonably likely to result from their application over time; 
  • Address why estimates or assumptions bear the risk of change and analyze, to the extent material, such factors as how you arrived at each estimate, how accurate your estimates/assumptions have been in the past, how much your estimates/assumptions have changed in the past and whether the estimates/assumptions are reasonably likely to change in the future; and 
  • Provide sensitivity analyses based on other outcomes that are reasonably likely to occur and would have a material effect, or information for investors to assess the probability of a future impairment charge when the estimates involve multiple, inter-related assumptions (such as the percentage by which fair value of goodwill exceeded carrying value at the date of the most recent step one test).

Accounting Standards Update  

Effect of a Loan Modification When the Loan is Part of a Pool That is Accounted for as a Single Asset (ASU 2010-18)  

According to the guidance in ASU 2010-18, modifications of loans that are accounted for within a pool under Subtopic 310-30 Loans and Debt Securities Acquired with Deteriorated Credit Quality do not result in the removal of those loans from the pool even if the modification those loans would otherwise be considered a troubled debt restructuring. However, an entity needs to continue to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. This Update is effective for qualified modifications of loans occurring in the first interim or annual period ending on or after July 15, 2010. Early application is permitted.

Milestone Method of Revenue Recognition (ASU 2010-17)  

ASU 2010-17 establishes a revenue recognition model for contingent consideration that is payable upon the achievement of an uncertain future event, referred to as a milestone. This Update provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Additional disclosures are also required for transactions that are accounted for under the milestone method. This Update is effective prospectively for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted.

Accruals for Casino Jackpot Liabilities (ASU 2010-16)  

This Update affects entities in the gaming or entertainment industries that involve jackpots. The amendment clarifies that an entity should not accrue jackpot liabilities (or portions thereof) before a jackpot is won if the entity can avoid paying that jackpot, effective for fiscal years beginning on or after December 15, 2010.

Effects of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades (ASU 2010-13)  

ASU 2010-13 addresses the classification of a share-based payment award with an exercise price denominated in the currency of a market in which the underlying equity security trades. Topic 718 Stock Compensation is amended to clarify that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades shall not be considered to contain a market, performance, or service condition. Therefore, such an award is not to be classified as a liability if it otherwise qualifies as equity classification. This Update is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.

Accounting for Certain Tax Effects of the 2010 Health Care Reform Acts (ASU 2010-12)  

The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (enacted on March 23, 2010 and March 30, 2010, respectively) affect the benefits employers proved to employees and retirees. On April 14, 2010, the FASB issued ASU 2010-12 which reflects an SEC staff announcement addressing the impact that the different enactment dates of the aforementioned Acts may have. The announcement states that the SEC would not object if registrants were to account for the enactment of both the Acts in a period ending on or after March 23, 2010, but notes that the SEC Staff does not believe that it would be appropriate for registrants to analogize to this view in any other fact patterns.

Scope Exception Related to Embedded Credit Derivatives (ASU 2010-11)  

The ASU amends guidance in Subtopic 815- 15 Derivatives and Hedging – Embedded Derivatives, to clarify the scope exception for credit derivatives embedded in securitized financial assets. As a result of this Update, more financial instruments will now be accounted for at fair value through earnings, include some unfunded securitized instruments, synthetic collateralized debt obligations and other similar securitization structures. The new guidance is effective at the beginning of the first fiscal quarter beginning after June 15, 2010. Early adoption is permitted. Entities are also allowed to elect the fair value option upon adoption.

The SEC is contemplating ending its practice of letting companies and individuals settle charges of wrongdoing without disclosure of the detailed findings of the SEC’s investigation. Under the current policy, companies and executives that settle cases filed by the SEC usually pay a fine and agree to other sanctions, but they neither have to admit wrongdoing or participate in a trial where the details of the alleged misconduct would become public record. The settlement can often be only a few pages in length and may be the only public record of the case. Securities lawyers have said that a more detailed public record may make defendants less likely to settle and make it easier for class-action lawsuits to piggyback the SEC’s claims. It could also lead to embarrassment for executives if the agency publicized their roles in violating securities law, even if they are not personally charged. “If you’re being accused of wrongdoing, it’s in your interest to have as few of the facts revealed as possible,” said Russell G. Ryan, a securities lawyer at King & Spalding. “To the extent that the SEC adopted a policy that would require a detailed recitation of the facts, companies might be more reluctant to agree to a settlement.” 


  • A free online tool to help preparers understand how the streamlined IFRS standard compares to U.S. GAAP is available online at The website was launched in January for understanding differences between the two sets of financial reporting standards. IFRS for small and medium sized entities (“SME”) is a simplified version of full IFRS aimed at meeting the needs of private company financial reporting users by eliminating some of the requirements meant specifically for public entities. This wiki was designed to provide a comprehensive and detailed comparison of IFRS for SMEs to U.S. GAAP when, previously, only high-level comparisons were available. When fully completed, this wiki will include comparisons of all sections of IFRS for SMEs and will be updated as new standards emerge. It was created by the AICPA Accounting Standards team and can be updated and edited by anyone in the profession.
  • The SEC has published a final rule, Adoption of Updated EDGAR Filer Manual, which includes revisions to the Electronic Data Gathering, Analysis, and Retrieval System (“EDGAR”) Filer Manual, to reflect updates in the system. The revisions were made primarily to: (a) support the upgrade of the Mutual Fund Risk/Return Summary Taxonomy; and (b) extend the interactive data/eXtensible Business Reporting Language (“XBRL”) validation requirements to all Exhibit 101 attachments. 
  • The PCAOB has advised auditors to be aware of unusual transactions that could be signs of fraud. In a statement, PCAOB chief auditor and director of professional standards Martin F. Baumann said “The PCAOB’s message to auditors, in this challenging economic environment, has consistently emphasized attention to audit risk and adherence to existing audit requirements.” Staff Audit Practice Alert No. 5, “Auditor Considerations Regarding Significant Unusual Transactions,” includes requirements from PCAOB auditing standards about significant unusual transactions which can help auditors detect potential errors or fraud while auditing or reviewing financial statements. The alert discussed subjects including identifying and assessing risks of material misstatement; responding to the risks of material misstatement; consulting others; evaluating financial statement presentation and disclosure; communicating with audit committees; and reviewing interim financial information. 
  • The Institute of Internal Auditors’ Internal (“IIA”) Audit Standards Board has proposed changes to standards for internal auditors. The IIA noted that internal auditors are increasingly providing opinions, both at the engagement level and at an overall level and that existing standards permit, but do not require, internal auditors to give opinions. The IIA stated that it does not believe all internal auditors should be required to issue opinions in every situation, but that if an opinion were given, it was one that could be relied upon. The proposed changes include the establishment of the expectations of the board and senior management in the planning process and establishment of the requirements for the work that must be completed if an engagement-level or an overall opinion is provided.

Concerns About Risks Confronting Boards First Annual Board of Directors Survey  

With heightened awareness of the need for corporate governance, American boardrooms are immersed in increasingly intense discussions about the issues of risk and compliance. With these new concerns, directors of public companies are under the microscope more so than ever before. While financial risk remains paramount, all systemic risks lead to financial risk in one way or another.

The EisnerAmper Intelligent Data (EisnerAmper ID) team recently compiled the thoughts of more than 100 directors serving on boards of publicly traded and private companies, of which 50 percent serve on audit committees. The survey explores not only financial risk, but the other important areas of risk being discussed in boardrooms, such as regulatory compliance and reputational risk, as well as how boards gain insight on new topics of interest to their companies. The survey results along with our analysis are presented in this report, These insights could impact your thinking and, we hope, spur important discussions.

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