Your Next Activist Shareholder May Not Want More Money

Shareholders are driving changes in corporate policies and disclosures unthinkable a decade ago, on issues ranging from protecting rain forests to human rights. Even the threat of a proxy vote can be enough to bring company executives to the negotiating table.

So far this year, environmental and social issues have accounted for 56% of shareholder proposals, representing a majority for the first time, according to accounting firm Ernst & Young LLP. That is up from about 40% in the previous two years, and means shareholders are increasingly voting on things like greenhouse-gas emissions, political spending and labor rights.

While such proposals usually don’t grab the same headlines as changes sought by activist investors, their proponents often are effective at persuading companies to meet them halfway.

The proposals are “really meant to get the attention of the corporate leadership,” said Thomas DiNapoli, the New York comptroller who oversees the $160.7 billion New York State Common Retirement Fund. “Profitability that is at a sustainable and responsible level is very, very important to us.”

Mr. DiNapoli filed about 65 resolutions this past year, and he often succeeds in getting companies to agree to his requests before they come to a vote.

Last week, he persuaded grocer Safeway Inc. to make products with palm oil produced in ways that don’t hurt rain forests. In February, in response to proposals from Mr. DiNapoli and others, AT&T Inc. published its first “transparency report” on requests from the National Security Agency and law-enforcement agencies for customer data and phone records.

In both cases, he withdrew his proposal after the companies agreed to make changes.

Resolutions calling on companies to report their political spending and lobbying efforts are the top two shareholder proposals this year, according to EY’s review of some 700 proposals. By contrast, last year’s proposals were dominated by traditional corporate-governance topics, such as eliminating staggered terms for directors and appointing independent board chairmen.

More surprising still are the results. Nearly 80% of companies in the S&P 500 index now disclose at least some information about their political-spending policies, according to the Center for Political Accountability, a practice virtually unheard of a decade ago. Some 53% now publish sustainability reports, according to the Governance and Accountability Institute, addressing such matters as their energy efficiency and labor standards.

And, about 22% have human-rights policies, according to the Conference Board, a private research group.

Among the reasons for this year’s surge in social and environmental proposals is the strong stock market, which has left shareholders little room for complaints about performance.

“You’re not seeing the same sort of push-back on executive compensation this year,” said Wendy Hambleton, national director of the Securities and Exchange Commission practice at accounting firm BDO USA LLP.

The shareholders who push for these proposals aren’t agitating for higher returns like activists Dan Loeb and Carl Icahn but rather are long-term investors at pension funds, unions and coalitions of socially conscious shareholders.

For example, the American Federation of State, County and Municipal Employees, a labor union for public employees, has been pressuring dozens of companies to disclose their lobbying activity this year. Ceres, a nonprofit group that advocates sustainable business practices, is helping investors at many companies write environmental resolutions.

As investors win battles at some companies, they hope peer pressure will convince others to follow suit.

On Monday, Exxon Mobil Corp. issued its first carbon risk report, explaining whether changing emissions regulations might move it to abandon high-cost oil and gas reserves. Sustainability-focused investment firm Arjuna Capital had submitted a shareholder resolution seeking that information.

Exxon said it was “confident” that none of its hydrocarbon reserves would become “stranded.”

“This is helping set the standard for what companies should be disclosing,” said Danielle Fugere, president of As You Sow, a nonprofit group that worked with Arjuna on the resolution. The group is circulating the agreement as an example for other oil companies where it has similar proposals pending, including Consol Energy Inc.,  Hess Corp., Chevron Corp. and Anadarko Petroleum Corp.

Of course, environmental and social resolutions generally aren’t binding and many never make it to a vote. Companies often can exclude them on technicalities, and about 30% are withdrawn after their backers negotiate or reach deals with companies.

Typically, the environmental and social proposals that make it onto the ballot receive about 21% of shareholder votes, compared with 33% for shareholder proposals overall, according to EY.

But even failures can have an impact, especially if investors target an issue that resonates with a company’s customers. Activists often cite a 1999 vote to halt sales of wood from old-growth forests at Home Depot Inc. Around 12% of the home-improvement chain’s shareholders supported the proposal, but the retailer stopped selling that lumber.

A handful of these resolutions have garnered a majority of votes. Last year, at fertilizer maker CF Industries Inc., shareholder proposals calling on the company to disclose political contributions and publish a sustainability report each received more than 65% support.

CF Industries initially objected, saying the reports would be costly to produce and “an imprudent consumption of our resources.” But it began producing them after the shareholder votes.

CF spokesman Daniel Swenson said the engagement with shareholders has “resulted in valuable feedback” and contributed to the company’s decision making. He wouldn’t say how much the reports cost to produce.

Shareholder proposals on these issues are expected to gather steam as more companies agree to disclosures. Boston-based Walden Asset Management has submitted several political-spending disclosure proposals to companies this year on behalf of clients. According to Timothy Smith, a director at Walden:

“We’re getting to the point where companies are not just listening to a squeaky shareholder, but doing this because they believe it is a good thing to do for the company,” 

By Emily Chasan at the Wall Street Journal 

FASB, IASB Can't Agree on Financial Instruments Accounting

YOU MIGHT have long suspected it, but now it's official: the IASB and the US Financial Accounting Standards Board have failed to develop a common financial instruments accounting standard. We have no convergence.

The reality about the lack of a single asset impairment model emerged during a 23 January IASB meeting. It leaves preparers playing piggy in the middle between the competing IFRS and US GAAP models.

Speaking at the meeting, Hans Hoogervorst, chairman of the IASB, said the two boards would meet later this year "once the two models are completely clear". Regulators, he explained, have the option of imposing "additional disclosures" in order to bridge the gap.

Hoogervorst, a former Dutch securities regulator and finance minister, added: "But we cannot let the preparers pay the price for the two boards not getting completely converged."

On 20 February there was worse to come. On the parallel effort to finalise the board's approach to classification and measurement, Hoogervorst was forced to concede: "What can we say? A lot of work has been done for nothing, it seems."

IASB member Patrick Finnegan was equally blunt in his assessment: "I would just observe the same thing. I joined this board with a full expectation that there were great aspirations for global convergence in three or four major areas. ... It is a terrible disappointment, in my opinion, for global investors.

"I'm not quite sure what more we can do if the two boards continue to work the problem ... but the FASB has decided not to continue with the current IFRS 9 proposed work plan that we developed, and unfortunately that's the way it is."

The board also voted to fix a new effective date for IFRS 9, Financial Instruments, of 1 January 2018. IASB members were reluctant to delay the standard, or make further changes to it, pending decisions on the linked insurance contracts literature.

Later that same meeting, staff reported that the FASB will almost certainly reject two central features of the IFRS 9 classification and measurement approach - the business model and the contractual cash flow assessments for amortised cost.

So how did it come to this? The IASB embarked on its project to replace IAS 39 in early 2009. It is possible to distill any number of motivations and drivers for the project: to respond to the financial crisis; to reduce complexity; to address the too-much too-late criticism of the IAS 39 incurred-loss impairment model.

The project began under the chairmanship of Sir David Tweedie, and glancing back at an official IASB project summary document from 2009, a fully-fledged classification and measurement, impairment and hedging model was supposed to be in place by the final quarter of 2010.

As is now plain to see, the board failed. In 2009, it issued the first completed phase of IFRS 9, which dealt with the classification and measurement of financial assets. It followed this in 2010 with a further module addressing financial liabilities and the fair value option.

In its 2013 iteration, the standard has acquired a new hedging model. This approach to hedging is something of a marmite experience. On the one hand, its supporters claim it will make hedge accounting available in more situations; its critics point to its complexity.

Also in 2013, the board put out proposals to add a new category - fair value through OCI [other comprehensive income] - to IFRS 9. Redeliberation of those proposals is now complete and the IASB has confirmed it will include the FVOCI category alongside fair value and amortised cost.

Since 2009, the standard has also featured a presentational option that allows entities to book gains and losses on fair value holdings of equity investments in OCI. And impairment? Well, the board published its first proposals in November 2009 and followed this with a so-called supplementary document in January 2011. The 2011 document marked the high-water mark of the convergence drive with the FASB.

From that point onwards, what was supposed to be a convergence effort degenerated into a religious war. If the pre-crisis years had been marked out by the clash of fair value and amortised cost, the new battle lines were between 12-months initial loan loss allowance and the FASB's preference for full lifetime expected losses on initial recognition.

And it was here that the convergence effort truly floundered. But as insurmountable though the technical challenges of two competing financial instruments models might appear, there is a much bigger issue: politics.

In recent weeks, the European Parliament has shown an increased willingness to challenge the IASB, even going so far as to propose linking funding for the IASB's activities to specific outcomes.

Separately, the G20 nations have urged the two boards to come up with a single financial instruments model. At some point in time, Hoogervorst is going to have a very awkward conversation with his political masters.

by Stephen Bouvier at Financial Director

Experts Say Use Non-GAAP Measures Carefully

Normalized adjusted EBITDA less capex. Adjusted consolidated segment operating income. Adjusted EBITDA (as adjusted). Even enthusiasts of non-GAAP metrics have to admit that such measures often sound just a wee bit ridiculous.

Non-GAAP metrics, those not addressed in U.S. generally accepted accounting principles, are as controversial as ever. A small number of such measures, like EBITDA and free cash flow, have gained widespread acceptance in the investor community. But regulators often give companies flak for the way they use non-GAAP measures in public filings, press releases and other communications consumed by investors and analysts.

Groupon, the perpetrator of “adjusted consolidated segment operating income” (ASCOI), took heat from the Securities & Exchange Commission in 2012 because the metric excluded online marketing expenses, a critical part of the firm’s business model, from company performance. Groupon eventually dropped the metric from its initial public offering filing, but it absorbed further criticism for its post-IPO use of other non-GAAP measures.

Black Box, a telecommunications company, got some bad press in January 2013, when it included the metric “adjusted EBITDA (as adjusted)” in its quarterly earnings release. The metric subtracted from net income ordinary expenses such as a $2.7 million loss on a joint venture, creating EBITDA (as adjusted), then further excluded stock-based compensation expenses to create the final, rather silly-sounding redundancy. Black Box said the measure demonstrated its ability to service its debt. Others thought it made the company look like well, a black box.

A common opinion is simply that non-GAAP metrics are misleading to shareholders. “They may be perfectly understandable to accountants who know what that company is doing but confusing to others,” says Michele Amato, partner at accounting firm Friedman LLP. Indeed, the SEC has long subjected companies that use non-GAAP metrics to heightened scrutiny, and the chairman of the commission’s new accounting-fraud task force has vowed to keep up the pressure.

But companies that use these black-sheep metrics argue that they often depict financial performance more accurately than GAAP measures and afford investors a window to how management sees things.

Public companies are allowed to disclose non-GAAP metrics in their SEC filings, press releases and earnings calls, subject to certain rules. Under Regulation G, mandated by the Sarbanes-Oxley Act, use of a non-GAAP financial measure must be accompanied by the most directly comparable GAAP measure and a reconciliation of the two metrics.

Everything in Moderation

For her part, Amato says there’s a place for non-GAAP metrics:

 “A very significant variance between GAAP and non-GAAP metrics that management uses as a baseline for internal financial analysis might be of some use,” 

There is nothing wrong with using a non-GAAP metric to provide an additional perspective about something very germane to the company’s performance, like its valuation, credit standing or working-capital management, that can’t be communicated well through GAAP metrics alone, says Robert Rostan, CFO and principal at financial training firm Training the Street.

Original article by Marielle Segarra ad CFO.com

Is the Smartest MD&A the One With the Most Jargon?

“Plain English Works” in MD&A Statements

Those who prepare MDAs don’t have to prove how smart they are by using financial jargon, suggests the SEC’s ex-corporate finance director.

Excessive financial jargon in documents filed with the Securities and Exchange Commission often clouds intended messages, said speakers at an American Institute of Certified Public Accountants conference this week.

The sentiment particularly applies to the Management’s Discussion and Analysis (MD&A) section of quarterly and annual reports and other registration statements, where companies generally discuss their business, uncertainties, and market trends.

“Everyone likes to prove they’re the smartest person in the room because they understand the jargon,” said Brian Lane, partner in the Washington, D.C., office of Gibson Dunn & Crutcher and former SEC director of the division of corporate finance. “Plain English works.”

The best MD&As have “more tables and less jargon,” Lane opined. Tables, he noted, are easier to understand than mounds of text. In the text, companies often include too many comparisons going back several years, which is often unnecessary and even confusing, he said. It’s better to show simple comparisons between this year and last year in both the text and tables, and include information on other years just in tables.

Making sure MD&As are as readable and informative as possible may ward off or lessen the impact of SEC inquiries, Lane added. One key to doing that: in all areas of focus within the section, answer the question “why?” he said.

Actually, having more tables in financial reports is a widening theme. The Financial Accounting Standards Board made a push in that direction this past summer, requesting comments on a proposal calling for nonfinancial companies to disclose expected cash-flow obligations in a table segregated by time of expected maturity.

For one, Katherine Gill-Charest, controller and chief accounting officer at Viacom, should be prepared if the proposal is approved. She already is including more than the usual amount of detailed information in the company’s MD&A statements. To facilitate that, she holds “working meetings” with members of Viacom’s disclosure committee a couple of times a year, instead of having just one formal meeting at reporting time to head off any questions that might arise from the SEC. She also meets with the CFOs of Viacom’s divisions to be aware of pertinent issues in preparing MD&As.

For example, the SEC repeatedly has asked for information on how Viacom plans to fund its $10 billion share-repurchase program. Other questions come when an SEC official hears of a trend during an earnings call that is not included in the MD&A.

Lane supported that use of a firm’s disclosure committee. A good item to discuss with that committee, for example, is “cash runway,” a measure of how long a company’s cash on hand will last, he said. A hoard of $300 million in cash is not actually that much if the company is burning through it at $90 million a quarter.
Knowing what questions the SEC may have raised with competitors is important, too.

 “If I know a peer of mine has gotten reviewed, we will always take a look at the SEC’s comments,” said Gill-Charest, noting that she treats any correspondence between a competitor and the SEC as if it were her own document.

That made sense to Lane:

“You do need to see what competitors and peers are disclosing, because the SEC is going to look at you in that same lens,” he said.

One area where some companies could ease up is their heavy use of forward-looking disclosure statements.

“Projections are not required in [the] MD&A,” said Lane. “You [just] have to talk about known uncertainties and how they could impact the future.”

By Kathy Hoffelder  at CFO.com

FASB vs IASB: Split on Lease Accounting

The US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) failed to reach a consensus for new lease accounting guidance Wednesday but vowed to continue working together in pursuit of consistency.

During two days of meetings at FASB’s headquarters in Norwalk, Conn., the boards failed to reach common answers on key areas of lessee and lessor accounting. In particular, the IASB favored a single approach for lessees for recognition of all leases, while FASB voted for a dual-recognition approach for lessees, depending on the type of lease.

The boards issued a joint statement saying they had agreed on areas such as lease term and short-term leases. The boards also pledged to continue working together on the standard.

“While differences remain, most notably in their preferred approaches to expense recognition, the boards are committed to working together to minimize these differences and to creating greater transparency around lease transactions for the benefit of investors worldwide,” the boards said.

The boards are attempting to create a converged standard that would eliminate a hidden liability for lessees by bringing leases onto corporate balance sheets. But they have struggled to agree on how to do it.

No consensus for lessee accounting

IASB members this week expressed a preference for lessees to account for all leases as the purchase of a right-of-use asset on a financed basis. In this “Type A” approach, a lessee would recognize amortization of the right-of-use asset separately from the interest on the lease liability for all leases.

FASB members preferred a dual-recognition approach for lessees that would use a Type A interest-and-amortization method for leases classified as capital leases under existing guidance, and a “Type B” single, straight-line lease expense for operating leases.

But there may still be a chance for convergence on this issue. FASB Chairman Russell Golden asked the FASB staff to work with the IASB staff to conduct research that would help the boards understand the effects of a possible exception that would permit preparers not to apply the proposed standard’s requirements to leases of small, nonspecialized assets.

The IASB voted for the so-called small-ticket exception, while FASB voted against it. Golden asked for the staff research in hopes that a better understanding of the exception could lead to convergence, which could cause the boards to agree on a preferred method of expense recognition.

FASB member Tom Linsmeier said he would be more inclined to consider the Type A-only approach for lessees if the boards abandon the small-ticket exception.

Sticking point for lessor accounting

On lessor accounting, meanwhile, the boards agreed to keep standards similar to current guidance but couldn’t agree on one important detail. They agreed that lessors should classify their leases as Type A or Type B based on whether the lease is effectively a financing or a sale rather than an operating lease.

But the IASB preferred to make that determination by assessing whether the lessor transfers substantially all the risks and rewards incidental to ownership of the underlying asset.

FASB preferred to make the leases guidance consistent with the requirements for a sale in the soon-to-be-issued revenue recognition standard. FASB’s approach would preclude recognition of selling profit and revenue at lease commencement for any Type A lease that does not transfer control of the underlying asset to the lessee.

The core principle of the new revenue recognition standard will be that revenue should be recognized to depict a transfer of promised goods or services to the customer.

Despite the disagreement on lessor accounting, some IASB members said they could accept the FASB approach, with IASB Chairman Hans Hoogervorst holding a “swing vote” that Golden suggested could move the lessor accounting decision to a converged answer in the future.

Before the boards parted, Golden thanked IASB members and said the boards ought to work together on the definition of a lease, disclosures, and other aspects of the leases proposal.

“We will continue to work together to improve accounting in this area, to continue to meet our objective,” Golden said, “and I hope to continue to minimize any differences.”

The boards have been working since 2006 to come to agreement on a leases standard. Their second exposure draft on the topic, issued in 2013, caused many preparers and some investors to question the benefits of the information—and the costs—the proposal would have generated.

By Ken Tysiac at JofA

IFRS To Run Out of Money?

The International Financial Reporting Standards (IFRS) Foundation’s role in governing global accounting rules is under threat after European politicians said they were questioning whether the authority was “best suited” to the position.

The London-based authority, responsible for setting standards in 100 countries, has been severely criticised by MEPs for poor governance structures, a lack of transparency and its “close links to the accounting industry”.

Last week the European Parliament approved a new £50m five-year funding programme for the IFRS’s standard setting arm, the International Accounting Standards Board (IASB).

However, MEPs attached a series of conditions to the deal and warned if they are not met, the funding could be stopped in a year’s time.

Sharon Bowles, chairman of the influential European economic affairs committee and a Liberal Democrat MEP, said: “Questions have been raised by the European Parliament about the governance structures and lack of transparency of these bodies, as well as their close links to the accounting industry.

"The release of these EU funding streams will therefore only be forthcoming upon sufficient reform to prevent conflicts of interest, which will bring about much-needed trust and scrutiny on how these highly influential public bodies operate.”

Syed Kamall, a Tory MEP for London, who has raised concerns about the IFRS rules, said: “I am not convinced that it was right for the EU to outsource standard-setting to what is, in effect, a private sector body funded by public money.”

A spokesman for the IFRS Foundation said:

 “The foundation takes seriously any such concerns and has already begun planning its constitutionally-required five-year review of its structure and effectiveness, to be undertaken during 2014, and we welcome any proposals to improve aspects of our work.”

The MEPs’ concerns about the IFRS Foundation’s governance were raised after The Telegraph first highlighted errors in the authority’s filings at Companies House in February. However, the politicians are also concerned IFRS accounting standards are seriously flawed.

Last year a group of British investors wrote to Michel Barnier, the EU’s internal markets commissioner, warning him that the accounting rules were harming shareholders and destabilising the economy. They argued that the IFRS rules, introduced in the UK in 2005, had allowed companies, and banks in particular, to hide the build-up of risks on their balance sheets.

The European Commission has said it will launch a review of the IFRS rules.

By Louise Armitstead, the Telegraph

11 Issues to be Aware of for Your Next Shareholder Meeting

U.S. public companies are operating in an environment full of both risk and opportunity as they prepare for their annual shareholder meetings.

Cyberthreats, disaster planning, and political and economic unrest are among many factors that make the current climate hazardous for many companies.

Although high values in the stock market indicate an environment that has improved significantly—if slowly—since the lowest depths of the global financial crisis, recent dips in the market indicate that volatility still exists.

Shareholders are likely to be focused on both the risks and the opportunities in upcoming shareholder meetings, according to Wendy Hambleton, CPA, a partner in the corporate governance practice who also heads up the SEC practice at BDO.

“There is still that overriding sense of still coming out of that economic downturn, whatever you want to call the period from 2007 to 2009,” Hambleton said. “I think people are cautious, so they want companies to be cautious and prudent with their funds. I don’t think people are pushing as much for huge growth as they are for measured growth and maybe a little more secure growth.”

Against this backdrop of risks and a desire for secure growth, BDO has compiled a list of issues in a news release that corporate management and boards of directors should be prepared to discuss with shareholders in connection with annual meetings this spring:

- M&A opportunities and takeover defenses. Is management seeking M&A opportunities? Are potential targets properly vetted to prevent buyer’s remorse? And are boards poised to fend off unwanted takeovers and maximize shareholder value if a transaction is accepted?

“We are seeing more M&A activity,” Hambleton said. “A lot of companies have some cash on hand, but I think everyone wants to be cautious to make sure plenty of due diligence is done, that it’s the right transaction, that it makes sense, no one is rushing into deals”

- Spinoff advocacy. Management and the board need to be prepared to respond to well-funded, activist shareholders who have the potential to try to break up companies, according to BDO. This can be a costly exercise, Hambleton said.

“If you’ve got activist shareholders making suggestions and urging the company to take certain actions, that takes a lot of time and in some cases dollars that the company might have wanted to use in an alternative way,” she said.

- Global economic concerns. Investors are concerned about how the crisis in Ukraine and slowing growth in China, Brazil, Japan, and other markets will affect the global economic recovery, according to the news release. Shareholders may ask about how prepared the company is to deal with a serious economic collapse in a certain country or region.

The crisis in Ukraine demonstrates that problems can occur in unexpected places, Hambleton said. And emerging markets pose different political and economic concerns than more mature markets such as the United States, Canada, and Western Europe, according to Hambleton.

“That’s not a reason not to go into those markets,” she said. “It’s just a reason to go in from a measured perspective. And from a shareholder perspective, that’s what people want to see is a measured perspective, that people are thinking about the risks, thinking about the concerns, and then taking a measured response to that.”

- Cybersecurity. Headlines about numerous high-profile breaches are certain to have shareholders’ attention, and companies should be prepared to explain their approach and their defenses. Hambleton notes:

“Companies need to be able to explain to shareholders—without getting into the minutiae of the details and what they do—how they monitor, what kind of controls they have in place,”  

“Have they looked at refreshing their risk management approaches in this area? How often do they do certain types of monitoring activities?”

- Executive compensation. Performance-focused compensation models at public companies have gained favor in the wake of new avenues for shareholder feedback, according to the news release.

Since regulations do not require disclosure of the relationship between pay and company performance, it appears that an emerging consensus is that disclosures should report how the company’s total shareholder returns relate to the CEO’s realizable pay, BDO said. Shareholders will ask more questions when the executives are compensated handsomely while the company struggles, Hambleton said.

- Succession planning. An improving economy may create more opportunities for executives to change jobs. This could cause shareholders to ask whether the board has a succession plan and has identified candidates for CEO and other key positions. Surveys have shown that board members are interested in this issue, Hambleton said.

“If it’s something board members would want to spend time on, you’d think it’s something shareholders care about, too,” she said.

- Accessing public equity markets. In 2013, total U.S. initial public offerings and proceeds raised reached their highest levels since 2000, according to BDO. This may lead shareholders to wonder whether management is considering new securities offerings.

“Certainly, a good IPO market is an opportunity for companies that may be looking at spinning off either their noncore businesses or businesses that maybe would perform better in a separate company rather than as part of the overall conglomeration,” Hambleton said.

- Disaster planning. Events such as Hurricane Sandy in the United States and Typhoon Haiyan in the Philippines have caused tragic losses of human life and disrupted supply chains and operations. Shareholders may want to know if businesses have backup plans that will minimize the effects of such events.

For example, Hurricane Sandy showed that backup servers located far apart on the same coast may be vulnerable to the same storm.

“No one probably envisioned a storm that would start where it did and go all the way and cause so many blackouts that we need to have [servers] on opposite coasts or in the middle of the country or something like that,” Hambleton said.

- New COSO framework. Shareholders may want to know if a company has updated its system of internal control to reflect the guidance in the updated 2013 framework of the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

“I wouldn’t expect there to be significant changes to companies’ assessments,” Hambleton said. “But the new framework does have more particular guidance built into it, so I think some of the controls and the mapping will need to change. There will be some work to do. Hopefully, some enhancement of controls will come out of it.”

- Conflict minerals. New SEC rules require public companies to report to the SEC whether their products contain certain minerals produced in mines in the Democratic Republic of Congo. In some cases, those mines are run by warlords who oppress residents of the region. Although some companies may be behind in gathering information needed to report on these minerals by the May 31 deadline for the 2013 calendar year, Hambleton said shareholders will have a wider perspective.

“They’re going to want to know if [the company is] going to have to report that they use conflict minerals,” she said. “And that gets into the whole question of sustainability and corporate social responsibility with companies.”

- Auditor tenure. Mandatory audit firm rotation no longer is part of the PCAOB’s agenda afterlegislative pushback on the issue, but BDO said management and audit committees should be prepared for shareholders to ask about the length of their auditor’s tenure and their process for hiring their auditors.

“If you’re an audit committee member, you will have heard the discussion, and you need to be prepared to answer the question, what consideration did they give,” Hambleton said. “Not that they should be making a change, but what consideration did they give to it?”

By Ken Tysiac Journal of Accountancy.

 

SEC Comment Letter Watch -- Segment Reporting

Segment reporting is one of the SEC's most common areas of comment. The SEC often asks for specifics of documents that the Chief Operating Decision Maker (CODM) reviews on a regular basis. Companies need to be cautious when answering similar questions since the next request from the SEC might be "please provide us with all regular reports that the CODM review on a regular basis." If the SEC sees something different in those CODM reports from the answer provided previously, that spells trouble. Here is a sample from a letter to Charter Communications:

SEC's question:
We note your response to comment 4. Please provide us additional information about all of the “certain operating metrics”, such as “CPE” and plant maintenance, that management, in particular the CODM, relies on to assess performance and allocate resources.

Describe for us what these non-financial business and operational data represent, at what level of detail does the CODM review them (e.g.KMA or lower), and how the CODM uses them to assess performance and allocate resources.

Company's answer:
Our CEO, as CODM, receives and reviews information at the consolidated level, whether financial or non-financial in nature, and uses that information to assess performance and allocate resources on a consolidated basis. The CEO routinely receives consolidated operating metrics that include customers by product (video, Internet, and phone), sales and disconnects by product, customer net gains, penetration of estimated passings, bundled customer statistics, sales channel performance, call center and truck roll statistics and headcount. In addition, the CEO receives certain statistics related to the quality of physical transactions occurring at a local level, specifically truck roll data and ratios which use the number of customer connections, disconnections and average customers by service to calculate service level ratios. These statistics assist with the review of activity in the field at the local level, but are not the primary data used for resource allocation. Our CEO makes resource allocation decisions to specific operating strategies that impact the performance of the consolidated company. Furthermore, he assesses the performance of the Company on a consolidated level as a result of the implementation of the company-wide operating strategies. The execution of those strategies is carried out by levels below the CODM.

Resources allocated to our strategic initiatives of enhancing the customer experience and increasing customer growth are driven on a consolidated basis by our CODM. One such example would be CPE procurement, which is budgeted based on a certain number of connects and devices per connect, both estimated for the entire company. Consequently, CPE is purchased on a company-wide basis in order to maximize scalability during negotiations with our vendors and to meet estimated connects on a company-wide basis. Plant maintenance is another example. The allocation of corporate resources to plant maintenance is based on the strategy to improve the performance and reliability of the network. Levels below the CODM are then tasked with execution of the strategy and ensuring resources are provided where they are needed. A third example is our strategy of our all-digital network roll-out. Again, the amount of resources required for the all-digital roll-out is based upon an allocation of resources to implement the roll-out company-wide. In executing the all-digital roll-out, managers below the CODM carry out the initiative within our footprint based upon the potential immediate impact on our customers. Other overall resource allocation examples include, but are not limited to, implementation of a back office system to support customer growth or a decision to change the type of modem used, both of which would be on a company-wide basis.

Cleaning Up OCI

Accounting ‘Dumping Ground’ Headed For Clean Up

International accounting rulemakers may focus on cleaning up rules for “other comprehensive income,” a category in a company’s earnings statement that can obscure the true profit and loss picture, the chairman of the International Accounting Standards Board said this week.

The board may restart its efforts to improve financial statement presentation guidance in this area and bring more “discipline” to the way companies decide what is classified as profit and loss or other comprehensive income, IASB Chairman Hans Hoogervorst said in a speech in Tokyo.

More than 100 countries use International Financial Reporting Standards, which are set by the IASB. The U.S. does not use them for domestic companies, but allows foreign companies to file their results with U.S. regulators under these standards. U.S. multinational companies often have to use these standards for foreign subsidiaries.

Other comprehensive income, which includes items initially excluded from net income in a particular accounting period, has gotten a reputation as a sort of dumping ground where companies are allowed store information that would be too damaging to earnings.

For example, he said passing employee benefit expenses through other comprehensive income, rather than earnings, has dis-incentivized companies from dealing with large liabilities head-on.

“In the last decade, some big American car manufacturers and airline companies were brought to their knees by employee benefits that had been building up over the years,” Mr. Hoogervorst explained. Such liabilities may not have been taken as seriously because they were in other comprehensive income, he said.

The other comprehensive income figure is crucial because it can distort common valuation techniques used by investors, such as the price-to-earnings ratio. If the profit and loss statement and earnings are the primary indicators of a company’s performance, they need “to be robust and tinker-free,” Mr. Hoogervorst said.

Mr. Hoogervorst said he’d been approached by Japanese accounting stakeholders about improving and clarifying other rules, as well as differences of opinion from other countries, such as Canada.

In an interview with CFO Journal, Dr. Nigel Sleigh-Johnson, head of financial reporting for the Institute of Chartered Accountants of England and Wales said Thursday, “At the moment there is no clear and consistent basis for,” other comprehensive income.

Accounting rulemakers should try to make it easier for companies to decide what items need to be recognized in profit and what has to go into other comprehensive income, he said.

The U.S. Financial Accounting Standards Board has also been working to clarify rules for other comprehensive income in the past few years and make the rules more transparent to investors.  The board issued new guidance on how companies should present the figures in 2011 and updated accounting standards on items reclassified out of accumulated other comprehensive income last February.

 Article by Emily Chasan, at the Wall Street Journal

Can Companies Smooth-Talk Investors?

Investors Prove Wise at Judging Self-Serving Earnings Explanations

Investors have proven to be sophisticated enough to dismiss implausible explanations from companies of their quarterly earnings results, according to a new study.

For example, a utility company might attribute their lower earnings to “warm weather and higher propane products costs,” while an insurance company might explain a good quarter by touting its “continued efforts on cost containment and operational efficiencies.” Self-serving attributions such as these, which typically blame outside factors for negative developments and claim that their own internal initiatives led to positive results, are a traditional part of corporate earnings reports and press releases. But that doesn’t mean investors generally believe them.

According to a new study in The Accounting Review, a journal of the American Accounting Association, market response to self-serving attributions depends in large part on two key tests of plausibility—how badly the company’s industry peers are doing and what the study calls “commonality,” the extent to which market or industry forces drive a company’s earnings.

The difference proved to be dramatic when those two key tests were applied to the 94 companies in the study, which was conducted by Michael D. Kimbrough of the University of Maryland and Isabel Yanyan Wang of Michigan State University. Firms with average positive earnings surprises who made the highest-plausibility attributions had three-day above-market returns of 4.77 percent on average, whereas those that offered the lowest-plausibility reasons actually averaged a slight decline of 0.79 percent. Meanwhile, among firms with average negative surprises, those with the lowest-plausibility attributions sustained average declines of 5.11 percent, while those with the highest-probability excuses had declines of only 1.42 percent.

“Firms which provide defensive attributions to explain earnings disappointments experience less severe market penalties when 1) more of the their industry peers also release bad news, and 2) their earnings share higher commonality with industry- and market-level earnings,” said the paper. “On the other hand, firms that provide enhancing attributions to explain good earnings news reap greater market rewards when 1) more of their industry peers release bad news, and 2) their earnings shares lower commonality with industry- and market-level earnings.”

 “Collectively, our results suggest that investors neither completely ignore seemingly self-serving attributions nor accept them at face value, but use industry- and firm-specific information to assess their plausibility,” the professors added. “Further analyses reveal that investors’ use of industry peer performance and earnings commonality information appears justified because investors’ perceptions are consistent with the association between the plausibility measures and the ex post actual persistence of earnings surprises.”

In sum, “investors are somewhat sophisticated when interpreting these narrative disclosures,” Kimbrough and Wang wrote:

“Our findings ought to be of value to both investors and corporate leaders,” said Wang in a statement. “Hopefully it will disabuse those executives who are counting on the naiveté of investors to let them get away with empty words or phony excuses in their public communications. For investors, it provides standards they will need to meet to keep up with the investment community at large.”

“The tools needed to apply those standards are certainly available to institutional investors, even though determining commonality is probably beyond the reach of individual stock-pickers,” said Kimbrough. “Still, even they should have the means to stack up the claims of a given company against its industry peers, which can go a long way in assessing the plausibility of the firm's performance narrative.”

The study's findings are based on an analysis of press releases and earnings reports of 94 randomly chosen firms, a roughly equal mix of small, medium and large, over a seven-year period. Sufficient data was obtained for a total of 1,790 firm quarters, 1,023 of which featured self-serving attributions and 767 of which did not. The self-serving classification was assigned to quarters when companies attributed their success in meeting or beating consensus forecasts to internal factors, such as management strategies or introduction of new products, or blamed a negative earnings surprise on external factors, such as bad weather or rising costs or regulatory actions. Firm-years in the self-serving category featured at least one such attribution and an average of three to four in a given earnings press release.

The authors found a significant relationship between the plausibility of self-serving attributions, as determined by industry performance and commonality, and the market-adjusted cumulative return of firms' stocks in the three days centered on earnings announcements. In reaching that conclusion, they controlled for an array of factors likely to affect the market’s response to earnings announcements, including the size of companies, the volatility of their stock, and their book-to-market ratio.

What kind of companies are likely to issue suspect attributions? Preliminary evidence suggests, in the words of the study, “Firms which provide less plausible attributions are larger and have higher likelihood of insider trading around earnings announcements, higher analyst following, higher institutional ownership, higher return volatility, and lower book-to-market ratio. These findings imply that managers with insider trading incentives and those facing greater capital market scrutiny are more likely to offer seemingly self-serving attributions even if they lack plausibility, consistent with the ‘opportunistic behavior’ view of capital markets.”

This view, according to the paper, finds “that capital-market scrutiny combined with the linking of manager compensation with stock prices creates pressure for managers to prop up prices by biasing financial reporting. To the extent capital-market pressure is greater for firms with higher analyst following and/or institutional ownership, the ‘opportunistic behavior’ argument suggests that greater analyst following and/or institutional ownership may increase managers’ tendency to provide implausible attributions to either mitigate market reactions to negative earnings surprises or to increase market rewards to positive surprises.”

Still, given the hazards of implausible attributions, as revealed by the new study, why would managers make them? It’s a matter of what they believe, Wang and Kimbrough wrote. “If managers believe there is a chance that investors might be persuaded by their implausible seemingly self-serving attributions, they are more likely to offer them even if ex post it turns out that investors can see through them.”

This article is by Michael Cohn in Accounting Today. The study, “Are Seemingly Self-Serving Attributions in Earnings Press Releases Plausible? Empirical Evidence,” appears in the March/April issue of The Accounting Review, published six times a year by the American Accounting Association.

More on Less Complexity in Financial Reporting

Want simpler financial reporting? If you believe the SEC’s public statements, reduction in complexity may be on the way.

Edith Orenstein has posted the following in the FEI Financial Reporting Blog. Here is her full post:

One recent development at the SEC that ties into FASB’s “combating complexity” goal cited further above, is that noted by SEC Chairman Mary Jo White concurrent December 20, 2013 issuance of the SEC staff report, Report on Review of Disclosure Requirements in Regulation S-K. The report was conducted by the SEC as requested by Congress under the JOBS Act.

Importantly, as noted in the SEC's press release, White stated:

“This report [on Reg S-K] provides a framework for disclosure reform. As a next step, I have directed the staff to develop specific recommendations for updating the rules that dictate what a company must disclose in its filings. We will seek input from companies about how we can make our disclosure rules work better for them and will solicit the views of investors about what type of information they want and how it can best be presented. The ultimate objective is for the Commission to improve the disclosure regime for both companies and investors.”

Keith Higgins, Director of the SEC’s Division of Corporation Finance stated:

“Updating our rules is only one step – albeit an important one – in improving company disclosures. For their part, companies should examine how they can improve the quality and effectiveness of their disclosures and how our rules can be improved to facilitate clear and effective communications to investors. Better disclosure benefits everyone in the marketplace, and we plan to work with companies and investors to achieve this common goal.”

The press release also noted that:

“The SEC’s Office of the Chief Accountant will coordinate with the Financial Accounting Standards Board to identify ways to improve the effectiveness of disclosures in corporate financial statements and to minimize duplication with other existing disclosure requirements.”

Chairman White led up to this initiative in remarks given at the NACD’s annual conference in November, 2013, as we noted in this post, SEC’s White Calls for ‘A Meaningful Review of Disclosure Requirements.’ 

Commissioner Dan Gallagher also focused on the need for disclosure reform in a speech at the 2nd Annual Institute for Corporate Counsel on December 6, 2013, excerpted below:

“We can’t foster capital formation in fair and efficient capital markets through private investment unless the critically important information about public companies is routinely and reliably made available to investors. We need to take seriously however, the question whether there can be too much disclosure. Justice Louis Brandeis famously stated that sunshine is the best disinfectant. As my friend and former colleague Troy Paredes pointed out some years ago, though, it is possible to create conditions in which investors are 'blinded by the light.' That is to say that from an investor's standpoint, excessive illumination by too much disclosure can have the same effect as obfuscation - it becomes difficult or impossible to discern what really matters ...”

“I often hear from investors that disclosure documents are lengthy, turgid, and internally repetitive. In their present state, they are, in other words, not efficient mechanisms for transmitting the most critically important information to investors — especially not to ordinary, individual investors. They are not the sort of documents most people are likely to read, even if doing so is in their financial self-interest. For that reason, today’s disclosure documents raise questions of what their purpose actually is and whether they are meeting it.”

“Here, it seems to me, we must acknowledge a dilemma. The good we have done in shaping a detailed disclosure regime to assist and protect investors has, in fact, led to some potential but, I submit, avoidable harm. Corporate disclosure filings didn’t naturally evolve into their present convoluted state. Rather, the rules that require periodic corporate reporting and the detailed instructions that implement them, as well as the staff interpretations and guidance that supplement those rules and instructions, have been the principal forces shaping modern corporate disclosure filings.”

“But other, external forces have played a role as well, most notably the risk of litigation -- much of it absolutely frivolous and solely for the benefit of plaintiffs’ lawyers, not investors. The failure to disclose anticipatorily is often enough to prompt a shareholder lawsuit based on the assertion of a material omission. It is rational, in other words, for those who prepare corporate disclosure documents to prepare for the worst, thus perversely prioritizing the need to avoid the penalties that accompany claims of insufficient disclosure, it seems, over rendering the required disclosure in a manner intelligible to the average investor. In sum, the Commission has cause for self-examination where the question of the utility and lucidity of corporate disclosures arises.”

“And in that process we cannot ignore the impact of excessive and frivolous litigation.”

“Here, we come to a fundamental fork in the road. Should we jump in with both feet to begin a comprehensive review and possible overhal of SEC-imposed disclosure requirements under the securities laws, or should we take a more targeted approach, favoring smaller steps towards our ultimate reforming goals? Ordinarily, I would argue for a comprehensive approach to the solution of almost any problem. Where securities regulation is concerned, we often find that actions we take in one area have unforeseen and unintended effects in others.”

“However, disclosure reform may be the exception. Although I've publicly called on multiple occasions for a holistic, comprehensive review of market structure issues, I believe, on balance, that with disclosure reform it is better to start addressing discrete issues now rather than risk spending years preparing an offensive so massive that it may never be launched. On this point, I was very pleased to see the recent remarks by Chair White (citing NACD speech). I hope and expect that, under her stewardship, the Commission will begin to make real headway on disclosure reform. I am genuinely enthusiastic about the prospect of solving some of the real-world problems that have become obvious to all who focus on this area. In short, it’s time to get practical and time to get started.”

Inquiring minds may ask: why have I not put “disclosure reform” as the highest priority item for 2014 as relates to the SEC, instead of “Enforcement”? Well, it’s not just because “Disclosure Reform” is two words, and “Enforcement” is one. I truly believe that with so much messaging from the highest levels of the SEC of a “get tough” attitude that we will see some illustrations of that attitude. We have seen that messaging from the Chairman, the Director of Enforcement, and in speeches from the Office of the Chief Accountant, and although preparers and auditors may prefer to see “disclosure reform” I believe that is a longer term project, and that in the shorter term, specifically 2014, attention should be paid to dotting the I’s and crossing the t’s as well as the big picture, substance over form, etc. with an eye toward Enforcement.

Slimming Down Disclosures: SEC Speaks Out

A targeted, step-by-step approach is the best way for the SEC to review and overhaul its financial disclosure requirements under securities laws, SEC Commissioner Daniel Gallagher said Monday.

In a speech at the Forum for Corporate Directors in California, Gallagher said he hopes the SEC can “make real headway” in its initiative to reduce unnecessary disclosures. And he said a piece-by-piece approach is preferable to addressing the issue in a comprehensive fashion.

“I would prefer to address discrete issues now rather than risk spending years preparing an offensive so massive that it may never be launched,” Gallagher said.

In December, SEC Chairman Mary Jo White instructed the commission’s staff to develop recommendations for updating what companies should be required to disclose in public filings. Gallagher said it’s time to get started on disclosure reform even though the SEC has yet to complete about 60 rules mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L. 111-203.

Here are some of the issues Gallagher said the SEC may need to focus on:

Layering disclosures. This would mean making key information easily available in a standardized format, while making additional details available elsewhere. Gallagher said material information, such as a company’s financial statements, could be treated differently from information that he said is not material, such as the Dodd-Frank pay-ratio disclosures the SEC is developing.

Streamlining Form 8-K disclosures. “Does each of the categories of information now required to be disclosed on Form 8-K really require almost immediate disclosure when a change occurs?” Gallagher asked.

Location, location. Authoritative guidance can be provided, Gallagher said, about where issuers must disclose or need not disclose particular types of information, enabling analysts and others to easily find the information or identify its absence.

Streamlining proxy and registration statements. Permitting some required financial information to be included in an appendix to the proxy would aid investors and preparers, Gallagher said. He also said it could be helpful if the SEC permits forward incorporation by reference in Form S-1 registration statements. This could simplify the registration process by allowing reference to previous forms.

The potential of technology. Gallagher suggested testing a standardized system that would require one-time online disclosure of basic corporate information, mandating that it be updated as necessary with changes tracked. “We have not come anywhere close to realizing the potential technology holds for improving our disclosure system,” Gallagher said.

Improving guidance. SEC disclosure guidance could be more reliable and authoritative if significant guidance was issued only with the explicit endorsement of the commission, rather than as staff guidance, Gallagher said.

Opposing politically driven disclosures. The SEC’s newly required conflict minerals disclosures were cited by Gallagher as an example of “ill-advised anomalies” that should not be the realm of an independent, bipartisan agency.

“From an investor’s standpoint, excessive illumination by too much disclosure can have the same effect as inundation and obfuscation—it becomes difficult or impossible to discern what really matters,” Gallagher said.

By Ken Tysiac a Journal of Accountancy senior editor.