May 24, 2007

SEC Adopts Voluntary 404 Guidance and Much More

Yesterday, the SEC adopted new guidance for management’s assessment of internal controls over financial reporting, which becomes effective 30 days after being published in the Federal Register. The new guidelines provide a principles-based framework, which is intended to promote a “healthy use of judgment” and provide companies with flexibility to establish an appropriate evaluation method. Here is Corp Fin Director John White’s opening statement, Chief Accountant Hewitt’s opening statement, Deputy Chief Accountant Zoe-Vonna Palmrose’s opening statement and a press release. FEI’s “Financial Reporting” Blog has more extensive notes about the meeting.

Although we don’t have the text of the new guidance yet, the SEC Staff said that the proposed core principles remain unchanged in their final form – but the Staff stated that there are some changes, mainly to align the guidance with what the PCAOB will adopt today at their meeting. The core principles are that management should evaluate whether it has implemented controls that adequately address the risk that a material misstatement in the financials would not be prevented or detected in a timely manner – and that management’s evaluation of evidence about the operation of its controls should be based on a risk assessment.

The SEC stated that its guidance makes clear that management can look to the principles-based guidance for carrying out its responsibilities. The new guidance doesn’t include examples because the SEC wants to avoid the unintended consequence of creating a “one size fits all” box. The SEC Staff stated that many larger companies have developed acceptable procedures for Section 404 reporting that differ from the interpretive guidance and that such procedures may continue to be used.

The SEC amended Rule 12b-2 and Rule 1-02 of Regulation S-X to codify the term “material weakness” substantially as proposed (the Staff stated that the PCAOB will adopt the same definition) to “a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility of leading to a material misstatement that will not be prevented or detected on a timely basis). The Staff explained that most of the material weakness situations seen so far involve accounting related issues within the areas of more complex accounting standards, such as taxes, revenue-recognition and the treatment of derivatives – and the new guidance addresses these areas.

The SEC amended Rules 13a-15(c) and 15d-15(c) to eliminate the requirement that auditors attest to management’s process of evaluating internal controls. In addition, the SEC amended Rules 1-02(a)(2) and 2-02(f) of Regulation S-X to require the expression of a single opinion directly on the effectiveness of internal control over financial reporting by the auditor in its attestation report.

The SEC also proposed a new definition of the term “significant deficiency,” which is intended to clarify those weaknesses that are considered to be less severe than a “material weakness.” Unlike “material weakness,” the proposed “significant deficiency” doesn’t include a probability threshold.

What the SEC Didn’t Do? Extend the Smaller Company Deadline Again

The SEC didn’t extend the deadline for smaller companies (those with less than $75 million in market capitalization) to comply with Section 404 since the new guidance provides scalable and flexible ways for these companies to meet the December 31st deadline. So unless the SEC reverses itself – which is still possible since Commissioners Atkins and Casey said they are still considering it – three delays was the charm. Following the SEC meeting, Senators Kerry and Snowe issued a press release saying it was a mistake not to adopt a fourth delay.

By the way, the SEC has announced the agendas and panelists for today’s and tomorrow’s proxy process roundtables (Evelyn Davis is on the Friday agenda; that alone should make it worthwhile). And the SEC adopted rules yesterday related to the Credit Rating Agency Reform Act of 2006.

The SEC’s Proposed Overhaul of Smaller Company Capital-Raising

Yesterday, the SEC also proposed a new framework for smaller company capital-raising. Here is an opening statement from the Corp Fin Staffers who shepparded this project. According to this press release, the proposals would include:

– A new system of securities regulation for smaller public companies that would make scaled regulation available to a much larger group of smaller companies (ie. up to $75 million in public float; up from $25 million), including killing the S-B system by integrating Regulation S-B into Regulation S-K and rescinding the SB Forms

– Modified eligibility requirements so companies with a public float below $75 million can use shelf registration

– A new Regulation D exemption from ’33 Act registration requirements for sales of securities to a newly defined category of “Rule 507 qualified purchasers” for which limited advertising would be permitted

– Shortened holding periods under Rule 144 for restricted securities (ie. reduced from one year to six months, unless a short sale is involved) and a few changes to Rule 145

– Two new exemptions for compensatory employee stock options so ’34 Act registration requirements would not be triggered solely by a company’s option granting practices

– Electronic filing of Form Ds

Hewlett-Packard’s Boardroom Leak: SEC’s Enforcement Brings a Form 8-K Case

So I guess filing those director resignation 8-Ks do matter after all. According to this press release, the SEC yesterday filed settled administrative charges with a cease and desist order (no fines or penalties) against Hewlett-Packard for failing to disclose the reasons for a director’s abrupt resignation in the midst of H-P’s controversial investigation into boardroom leaks.

The SEC found that several months before the public revelation of the company’s leak investigation, an H-P director objected to the company’s handling of the matter and resigned from the Board, yet H-P failed to disclose the reasons for his resignation as required under Item 5.02(b) of Form 8-K. Here is the SEC’s administrative release.