FSA Flashcards
SASB
2011: address the need for a shared understanding of how non-fin info impact perf; develop industry-specific stds; disclose material decision-useful sust info.
US Supreme Court def of materiality
Collection, mgt and report of sust info: relevant, reliable, comparable; decision, RM, strategy
Identify, quantify and comm sust factors that are material to fin cond and op perf
Business reporting
The information that a company provides to help investors with capital allocation decisions about the company
Sustainability
The concept of sustainability, or sustainable development, was defined in the Brundtland Report (Our Common Future) as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.”
Changing Valuations
In 1975, only 17 percent of the assets in the S&P 500 were intangible; in 2010, the number was 80 percent.
Sustainability Issues Are Business Issues
Approximately 90 percent showed a non-negative relation between sustainability criteria and corporate financial performance.
80 percent of CEOs believe that their company is approaching sustainability as a route to competitive advantage; just 14 percent of investors believe the companies they invest in are doing so
Existing, Evolving, and Emerging Regulation
2014 the E.U. adopted an amendment to its general accounting directives
SEC has issued specific guidance on a handful of sustainability issues—most notably climate change in 2010. The SEC also launched a Disclosure Effectiveness Initiative in 2013 with the goal of improving the quality of disclosures and issued a related Concept Release in April 2016
United Nations-supported Principles for Responsible Investment (UNPRI) Sustainable Stock Exchange Initiative
2017, the London Stock Exchange Group released “Your Guide to ESG Reporting,”
“universal owner” approach (fiduciary duty)
Consider not only portfolio-level returns, but also the opportunity to stimulate wider economic growth, which is also in the best interests of their beneficiaries.
“universal owner” approach
Consider not only portfolio-level returns, but also the opportunity to stimulate wider economic growth, which is also in the best interests of their beneficiaries.
Uniform Prudent Investor Act (UPIA) 1994
Fiduciaries, who have a duty of prudence, benefit from considering material sustainability information as sustainability becomes increasingly relevant to a company’s performance, for both risk management and growth opportunities.
Securities Act of 1933
regulates the sale of securities to the investing public. Before a company can offer securities under federal jurisdictional means, Section 5(c) of the Securities Act requires companies to fully and truthfully disclose information about the company in a registration statement filed with the SEC.
Disclosure as the Basis of the Securities Acts: to protect investors by promoting full disclosure of information thought necessary to informed investment decisions
Securities Exchange of 1934
regulates the stock exchanges and provides ongoing reporting requirements of companies that register securities with the SEC
gives the SEC the power to establish rules to regulate speculation and market manipulation on the stock markets.
Rule 10b-5, 1942, prohibits the making of misleading, untrue statements or engaging in fraud or deceit in the purchase or sale of any security.
Section 12 of the Exchange Act prohibits trading of securities on a U.S. stock exchange unless they are first registered, and the information requirements are similar to the Securities Act’s disclosure requirements for new securities issues
Section 13 of the Exchange Act contains the periodic reporting requirements
The Exchange Act gives the SEC authority to establish accounting principles for the companies that register securities (the “registrants”). In 1938, the SEC commissioners voted to allow the private sector to establish generally accepted accounting principles (“GAAP”) to guide the preparation of financial statements; oversee AICPA - FASB.
SEC
protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation
Sarbanes-Oxley Act (SOX) of 2002
SEC oversight power over the newly formed Public Company Accounting Oversight Board (“PCAOB”).
PCAOB
Protects investors and the public interest by working toward useful independent audit reports and by establishing standards for audits and auditors
Early Statements on GAAP
1932, the American Institute of Accountants (“AIA”) recommended five generally accepted principles of accounting to the NYSE.
1938, the AIA’s Committee on Accounting Procedure (“CAP”) began to publish Accounting Research Bulletins (“ARB”) - give the SEC authoritative support for the GAAP
1939, an AIA committee recommended that the auditor’s report contain the language “present [financial information] fairly … in conformity with GAAP
APB
1959, the AICPA established the Accounting Principles Board (“APB”) to reduce variation in accounting practice
Decision-Usefulness Enters the Lexicon
1966, the AAA (American Accounting Association) published A Statement of Basic Accounting Theory (“ASOBAT”) that deemphasized the asset valuation purpose of financial statements and instead focused on their decision-usefulness
Effectively linked decision-usefulness to the information required to make investment decisions: using discounted future cash flows as the most relevant attribute of assets and liabilities.
FASB
Dissatisfaction over APB’s inability to propose and support for accounting principles
1970, the APB affirmed the decision-usefulness objective
1971, the AICPA formed two special committees to address consternation over the APB’s inability to propose standards: the Trueblood Committee and the Wheat Committee
1973, in Accounting Series Release No. 150, the SEC recognized the FASB as the authoritative source of GAAP shortly after the FASB’s formation
Trueblood Committee
Propose the objectives of financial reporting, based on the underlying belief that identifying objectives would help improve financial reporting
Seconded the decision-usefulness objective of ASOBAT
Wheat Committee
identifying ways to improve the establishment of accounting standards
1973 FASB
SFAC No. 1, 1978 (Statements of Financial Accounting Concepts)
primary purpose of financial reporting as “provid[ing] information to help present and potential investors and creditors and other users in making rational investment, credit, and similar decisions.
SFAC No. 2, 1980
Characteristics of decision-useful information:
relevance (timeliness, predictive value, and feedback value)
reliability (free from error and bias and faithful representation)
neutral (not favoring one’s economic interest)
comparability
material / large enough magnitude to affect decisions
benefits > costs
SFAC No. 8, 2010
replace 1&2
characteristics are: Relevance -> materiality; Faithful representation (complete, neutral, and free from error)
To enhance the relevance and faithful representation of the information: Comparable; Verifiable; Timely; Understandable;
November 2014, the FASB announced a tentative decision to revise the description of materiality in SFAC No. 8 to state that materiality is a legal concept
TSC v. Northway 1976
Exchange Act 14(a) and Rule 14a-9 in that it omitted material facts
There must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ”total mix” of information made available.
Court: a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder
-> information needs only to be likely to be considered by the reasonable shareholder.
Basic v. Levinson
Court: emphasized that materiality is a question of law applied to the specific facts of a case.
Denied merger speculation
Been false or misleading – in violation of Section 10(b) of the Exchange Act and Rule 10b-5 – and that shareholders were injured by selling their shares at prices artificially depressed by those statements.
probability/magnitude test
Exchange Act Section 10(b) and Rule 10b-5
prohibit: (1) the use of deceptive devices or schemes, (2) the making of a material misstatement or omitting information such that the statements made are not misleading, and (3) committing a fraud or deceit, in the sale or purchase of securities.
Exchange Act 14(a) and Rule 14a-9
omitted material facts
Reese v. Malone 2014
Rule 10b-5 suit, alleging that British Petroleum (“BP”) and certain executives made materially false and misleading statements about their knowledge of corrosion in an oil pipeline, which later experienced a large spill
Court: facts demonstrating public interest in the withheld information demonstrate its materiality; disclosure that BP may have ignored significant warning signs would have altered the total mix of information made available to investors.
Staff Accounting Bulletin No. 99, SEC
not use financial thresholds or rules of thumb to make ultimate materiality determinations
NRDC’s Rule-Making Petition
Natural Resources Defense Council
1971 asking the Commission to expand civil rights and environmental disclosure under the federal securities laws.
The federal district court ordered the SEC to work on two critical factual issues regarding materiality: prevalence of “ethical investor”; other avenues
SEC to conclude ethical investing was not an important or significant type of investing: <1% of the total value of stocks and bonds in the United States in 1974 was invested using ethical investing principles; SHP between 2-3% support from voting stockholders during the 1970s
decided to adhere to an economic understanding of materiality; could not require disclosure solely for the purposes of changing corporate behaviour… contradicts with some occasion
In 1978, it issued new requirements for disclosing attendance statistics, as well as the committee structure of the board of directors to increase the corporation’s accountability to society. In 1992, it expanded disclosure of executive compensation in response to public outcry over compensation levels.
Regulation S-K Requirements for Form 10-K
Description of business 101 (101(c)(1)(xii) expressly requires disclosure regarding certain costs of complying with environmental laws)
Legal proceedings 103
Risk factors 503
MD&A Section Disclosure 303
discuss its overall financial condition, results of operations, and management’s view of known trends and uncertainties that are reasonably likely to have a material effect on results of operations and financial condition
disclose “known trends or uncertainties that the registrant reasonably expects will have a material impact on net sales, revenues, or income from continuing operations.”
focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.
The Commission’s 2003 interpretive release reminds issuers of three main goals of MD&A disclosure:
- To provide a narrative explanation of a company’s financial statements that enables investors to see the company through the eyes of management;
- To enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and
- To provide information about the quality of, and potential variability of, a company’s earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance.
1989 Interpretive Release
distinction between required disclosure and voluntary forward-looking information to be included in MD&A.
In determining whether a known trend or uncertainty is reasonably likely to have a material effect, the Commission advises management to ask two questions:
(1) Is the known trend, demand, commitment, event, or uncertainty likely to come to fruition? If management determines that it is not reasonably likely to occur, no disclosure is required.
(2) If management cannot make that determination, it must evaluate objectively the consequences of the known trend, demand, commitment, event, or uncertainty, on the assumption that it will come to fruition. Disclosure is then required unless management determines that a material effect on the registrant’s financial condition or results of operations is not reasonably likely to occur.
The Securities Act and the Exchange Act contain safe harbors for “forward-looking statements” that predate the Private Securities Litigation Reform Act of 1995 (PSLRA)
“meaningful cautionary statements identifying important factors that could cause actual results to differ meaningfully from those in the forward-looking statement.
Four points regarding the focus and content of MD&A:
- material information
- KPIs
- known trends and uncertainties that are reasonably likely
- Analyze the information that is disclosed
SEC’s Climate Change Guidance
- The impact of legislation and regulation
- International accords
- Indirect consequences of regulation or business trends
- Physical impacts of climate change
Consequences of Inadequate Disclosure
Exchange Act Section 10(b) and Rule 10b-5 - material omissions and misrepresentations
Exchange Act grants authority to the SEC to bring civil actions for aiding or abetting antifraud violations of the securities laws
SEC can provide comments to a company regarding the adequacy of its disclosures. The company must respond
(sanctions and delisting)
SOX 2002
1) the material accuracy and fair presentation of the disclosures in the report,
(2) that the issuer has established and maintained effective disclosure controls and procedures, and
(3) inadequacies in, or material changes to, internal controls over financial reporting.
disclosure requirement of Exchange Act Rule 12b-20.
Disclosure Effectiveness Initiative SEC
MD&A disclosure is more about principles-based requirements than about line-item, rules-based requirements
making disclosure more effective, not only about reducing the amount of disclosure.
dual goals of streamlining requirements for companies, including emerging growth companies, and focusing on useful, material information for investors.
1991, the AICPA formed the Special Committee on Financial Reporting (also known as the Jenkins Committee) because of concerns about the relevance and usefulness of business reporting
include valuable non-financial information; captures drivers of long-term value creation (forward-looking statement)
Association for Investment Management and Research (“AIMR”), now CFA
Financial Reporting in the 1990s and Beyond 1993: inancial statements are one component of a comprehensive business reporting model that serves users, and the report encouraged management to “disclose and discuss their strategies, proposed tactics and plans, and expected outcomes.”
