April 13, 2018

Rule 701: An Enforcement Sweep?

Broc recently blogged about last month’s Rule 701 enforcement proceeding against Credit Karma. As he pointed out, Rule 701 enforcement actions are pretty rare, but this “Compliance Week” article suggests that more may be on the way – thanks to an enforcement “sweep” being conducted out of the SEC’s San Francisco regional office. This excerpt says the sweep’s another reminder that private companies aren’t immune from SEC scrutiny:

“They came out pretty loudly in 2016 and said they had concerns that, as private companies grow ever-larger without going public, the SEC Enforcement Division ought to be paying more attention to those companies,” says Michael Dicke, co-chair of law firm Fenwick & West’s securities enforcement group, formally associate regional director for enforcement in the SEC’s San Francisco regional office.

“Everybody needs to understand that just because you are not a public or publicly reporting company you cannot think that the securities laws don’t apply to you. It doesn’t mean that the SEC cannot investigate you.”

Recently the Enforcement Division conducted a “sweep” through its San Francisco office and sent Rule 701 information requests to large pre-IPO companies.

“When they do a sweep, they are not targeting a particular company—and when they ask for information, they usually have a specific reason to ask for it,” Dicke explains.

The article says that the sweep may have been prompted by employee complaints about companies’ failure to provide the disclosures required under Rule 701.

Tax Reform: Earnings Disclosures Aren’t Getting Easier. . .

This “Audit Analytics” blog reports that tax reform’s impact has added complexity to 4th quarter earnings disclosures – and that its effects on earnings will remain a moving target throughout the year:

Although the SEC issued guidance on how companies should explain the Tax Cut and Jobs Act’s impact in their fourth quarter earnings releases, the SEC said companies can use “reasonable estimates” to report charges or benefits now and update those figures later.

From a practical perspective, it means that the numbers may change throughout the year and that we would not understand the full impact of the tax reform until the end of 2018. While the Commission provided a general guideline, certain nuances of the disclosure such as presentation in the non-GAAP section, are out of the scope of the guidance.

In the past few years, aggressive non-GAAP adjustments were criticized more than once for masking significant expenses. Yet, in this case, companies almost have to exclude the one-time tax reform impact from the non-GAAP EPS data during earnings calls to give investors a more-accurate picture of company’s earnings.

The blog notes that 80% of S&P 500 companies adjusted their GAAP EPS for the impact of tax reform. Of those, 72% present the adjustment as a separate line item, while 28% combined it with other tax related items. Audit Analytics says it’s important to differentiate between adjustments related to tax reform & other non-standard tax adjustments, and points out some disclosure practices that it views as potential “red flags.”

Tax Reform: Financial Statement Impact

Tax reform disclosures are challenging because the legislation impacts financial statements in so many ways. Unrepatriated foreign earnings, tax levies, stranded tax effects, valuation allowance and disclosures all need to be addressed in financial reporting. This FEI blog reviews the potential impact of tax reform on each of these matters. Here’s an excerpt addressing stranded tax effects:

The tax effect related to changes in the tax law is always reflected in income tax expense (or benefit) from continuing operations, regardless of where the related tax provision or benefit was previously recorded. For entities that must remeasure for example, their available for sale security deferred tax positions for the new rate change, that may create a mismatch with the remeasured deferred tax position and the contra-AOCI asset or liability embedded in ‘All Other Comprehensive Income.’

Under FASB ASU 2018-02, entities must reclassify the stranded tax effects from AOCI to retained earnings for each period in which the effect of the tax rate change is recorded. The amount of the reclassification would be the difference between (1) the amount initially charged or credited directly to OCI at the previously enacted U.S. federal corporate income tax rate that remains in AOCI, and (2) the amount that would have been charged or credited directly to OCI using the newly enacted 21 percent rate, excluding the effect of any valuation allowance previously charged to income from continuing operations.

John Jenkins