# Presentation: 164429

## CURRENT DEVELOPMENTS IN THE DIVISION OF CORPORATION FINANCE

**  **

**National Conference on Current SEC & PCAOB Developments**
**December 6, 2004**

## The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees.  Therefore, the views expressed today are our own,  and do not necessarily reflect the views of the Commission or the other members of the staff of the Commission.

***The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees.  Therefore, the views expressed today are our own,  and do not necessarily reflect the views of the Commission or the other members of the staff of the Commission.***

***Disclaimer***

## Corporation Finance

**Overview**
**Financial Reporting and Disclosure Issues**

## Corporation Finance

**OVERVIEW**
**Craig Olinger**

## Accounting Branch Chiefs

**Health Care & Insurance **
**      ****James Atkinson**
**Consumer Products **
**Michael Moran**
**George Ohsiek**
**Computers & On Line Services**
**Stephen Krikorian**
**Brad Skinner**
**Natural Resources & Food**
**        ****Jill Davis**
**Structured Finance, Transportation & Leisure**
**Linda Cvrkel**
**Michael Fay**
**David Humphrey**

## Accounting Branch Chiefs

**Manufacturing & Construction**
**	****John Cash**
**	****Rufus Decker**
** ****Financial Services**
**	****John Nolan**
**	****Kevin Vaughn**
** ****Real Estate & Business Services**
**	****Kathleen Collins**
**	****Donna DiSilvio**
**Emerging Growth Companies**
**	****Hugh West**

## Accounting Branch Chiefs

**Electronics & Machinery **
**	****Brian Cascio**
**	****Daniel Gordon**
**Telecommunications**
**	****Terry French**
**	****Robert Littlepage**
**	****Kyle Moffatt**

## Financial Reporting and Disclosure

** ****SOX Section 404 and 302**
** ****Use of Other Auditors**
**	****	****Louise Dorsey**
**	****	****Stephanie Hunsaker**

## SOX Section 404 and 302

***Effective Date for 404***
***404 vs. 302 Requirements***
***Interaction of 404 and 302***
***Evaluating ICFR***
***Management’s Report***
***FAQs***

## Effective Date of 404 for Accelerated Filers

***10-K due March 16, 2005***
***11/17/04 – SEC postponed final phase-in period for one year***
**Annual report deadline still 75 days**
**Quarterly report deadlines still 40 days**
***Accelerated filing phase-in resumes for FYE ending on or after 12/15/05***
**Annual report- due in 60 days**
**Quarterly report- due in 35 days**

**Notes:**
The Commission postponed for one year the completion of the final phase-in of the accelerated filing deadlines to allow additional time and opportunity for accelerated filers and their auditors to focus their efforts on complying with our new requirements regarding ICFR

## Effective Date of 404 for Accelerated Filers

***11/30/04 – Exemptive Order***
***45 Day Extension for cos. with ***
***<$700 mil market cap at end of 2******nd****** Qtr***
***10-K still due March 16, 2005 ***
**All required items except 404 reports  **

## Effective Date of 404 for Accelerated Filers

***10-K/A should include:***
**Two 404 reports**
**302 certifications**
**307/308 disclosures, revised as needed**
**Consent, if necessary (i.e. shelf   offerings, etc)**
***Due 5/2/05 for calendar year filers***
***Co. not timely for S-3 until 10-K/A filed***
***No 12b-25 on the 10-K/A***

## 404 vs 302 Requirements

***404 – ICFR******	***
_***Annually***_*** assess ICFR***
***Review conducted as of ***_***year-end***_***	***
_***Quarterly ***_***evaluation of any changes in ICFR***
***Documentation requirements for auditor to test******	***
***Internal control report***

***302 – DCP***
_***Quarterly ***_***assess DCP***
***Review conducted as of ***_***quarter ***_***and ***_***year-end***_
_***Quarterly ***_***evaluation of any changes in DCP***
***N/A – no auditor testing requirements***
***Officers’ certification***

## Interaction of 404 and 302

***Substantial overlap DCP and ICFR***
**DCP includes components of ICFR that provide reasonable assurance that transactions are recorded as necessary to permit preparation of F/S in accordance with GAAP**
***Key differences***
**DCP – apply to material financial **_**and **_**non-financial information required in public reports**
**ICFR covers items that do not directly relate to disclosure**

## Interaction of 404 and 302	

***To the extent that ICFR impacts public disclosure, DCP are inclusive of such internal controls****** ***
***Disclosure controls apply to all material information to be included in financial reports, both within & outside f/ss***

## Interaction of 404 and 302

_***Question***_
***Could you have a situation where CFO/CEO reach a conclusion in their 302 certifications that DCP are effective at reasonable assurance level, even though there is a material weakness in ICFR?***

**Notes:**
Per Alan’s speech (Glasser LegalWorks – 7/20/04) – answer is theoretically yes.  There are some, but not a substantial amount of elements of ICFR which are not directly relevant to DCP.  For example, pure safeguarding of assets
We think the conclusion to reach a yes in this case is HIGH.  The reason is that is that the concept of material weakness in the area of ICFR is ultimately a weakness that leads to a more than remote likelihood of a material misstatement.  Also, AS 2 makes it clear that at least in some circumstances, in evaluating whether there is a MW, you can take into account countervailing controls.  So once you found a MW, the CEO/CFO are going to have to conclude that notwithstanding the MW and notwithstanding that the countervailing controls were already taken into account in determining that there was a MW, nonetheless mgmt can reach a conclusion with reasonable assurance that the disclosure controls are effective.  WE DO NOT BELIEVE THIS IS AN EASY CONCLUSION TO REACH.  A number of filings have been made with us that suggest that the conclusion could be reached.  In certain circumstances we would think that it is essentially impossible to reach that conclusion where the MW exists in certain areas; the most obvious, where there is a MW in fraud prevention controls.  There is a multiplicity of MW where this would again essentially be an impossible task.
If management were going to conclude for purposes of its certification, we will expect mgmt, if there is a MW in ICFR and mgmt nonetheless believes the DCP are effective, they will make that clear and explain why.  We are not looking for 5 pages of boilerplate – it should be something clear and succinct and convincing that the analysis has been made and that mgmt has reached the conclusion and is standing behind it

## Interaction of 404 and 302

_***Answer***_
***Generally officers will not be able to conclude DCP are effective when material weaknesses have been identified in IFCR***
***But......***
***There may be some limited circumstances***

## Interaction of 404 and 302

***Some elements of ICFR are not directly subsumed within the definition of DCP****** ***
**Example in 404 adopting release– pure safeguarding of assets**

## Interaction of 404 and 302

***Likely impossible to conclude DCP are effective when material weaknesses exist in certain areas:***
***Example:***
**Material weakness in fraud prevention**
**Multiple material weaknesses**

## Interaction of 404 and 302

_***Question***_
***What if a company has to restate its F/S because it or the auditor discovers a material weakness in ICFR that is also part of the company’s DCP?  ***

## Interaction of 404 and 302

_***ANSWER***_
***Need to consider whether the disclosures provided under Item 307 in original filing must be: ***
**modified, supplemented or corrected **
**in order to explain relationship between failure of DCP and restated F/S**

## Interaction of 404 and 302

***If officers conclude original conclusions are no longer correct:***
**Disclose this fact based on duty to correct a misstatement when it became known and Rule 12b-20**

**Notes:**
Rule 12b-20 requires the “in addition to the information expressly required to be included in a statement or report, there shall be added such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made not misleading.

## Interaction of 404 and 302

_***Question***_
***Can the officers conclude DCP were ***_***not effective***_*** as of end of reporting period covered by amended report, but conclude DCP ***_***are effective***_*** as of date the amendment filed?***

## Interaction of 404 and 302

_***Answer***_
***Yes – ***
***Company should expand disclosure to explain how mgmt determined DCP are now effective given the material weakness and other matters identified***

## Interaction of 404 and 302

***Other Areas for Disclosure?***
_***MD&A Disclosure***_
**Material weakness in ICFR may constitute a material trend or uncertainty that should be disclosed in MD&A**
**Detailed discussion of material weakness**
**quantification and analysis of associated uncertainties & trends**

## Evaluating ICFR

***Will vary among companies***
***No specific method or procedures required ***
***Must be based on procedures sufficient to evaluate both ***_***design***_*** & ***_***operating effectiveness***_
***Documentation & evidential matter is key***
**Inquiry alone not adequate!**

**Notes:**
The methods of conducting evaluations of ICFR will, and should, vary from company to company.  Therefore, the final rules do not specify the methods or procedures to be performed in the evaluation.  The nature of a company’s testing will largely depend on the circumstances of the company and the significance of the control.  However, in conducting the evaluations and developing your assessment of ICFR, you must maintain evidential matter, including documentation, to provide reasonable support for management’s assessment of the effectiveness.  Developing and maintaining such evidential matter is an inherent element of effective internal controls.

## Evaluating ICFR

***Mgmt must attain the level of “reasonable assurance” when formulating conclusions regarding effectiveness of ICFR***
_***Reasonable Assurance***_
**Conforms to current auditing literature (AU 319)**
**Mgmt must use judgment **
**Implies consideration by mgmt of the cost of the control and its benefits in reducing risk**

## Management’s Report	

***No standard format***
_***Certain statements to be included:***_
**Management’s responsibility for ICFR**
**Framework used**
**Mgmt’s assessment of the effectiveness of ICFR, as of end of most recent year**
**Auditor has issued report on ICFR**
**Disclosure of any material weaknesses**

## Management’s Report, cont’d

_***Other Requirements***_***:***
***Report should be located in “close proximity” to auditor’s attestation report***
***If management’s report contains additional information (i.e. plans, corrective actions to be taken, etc.)***
**Auditor to disclaim additional information**

**Notes:**
Per par. 190-191 of AS#2

## Management’s Report

_***2 Possible Options***_
**Effective**
**Not Effective**
**Prohibited from concluding effective ICFR if one or more material weaknesses**

**Notes:**
However, Mgmt may be able to accurately represent that ICFR, as of the end of the most recent FY, is effective even if one or MW existed during the period.  To make this representation, mgmt must have changed the ICFR to eliminate the MW sufficiently in advance of the “as of” date and have satisfactorily tested the effectiveness over a period of time that is adequate for it to determine whether, as of the end of the fiscal year, the design and operation of ICFR is effective (per FN 165 of AS#2)  However, when the reason for change in ICFR is the correction of a MW, mgmt and auditor should evaluate the need for change and the circumstances surrounding the change are material information necessary to make the disclosure about the change not misleading in a filing subject to certification under 13a-14(a) or 15(d)-14(a).

## Management’s Report

***What if management does not have the ability to assess certain aspects of ICFR?***
_***Example***_***:***
***SAS 70 report not available at service organization and no other ability to assess controls in place at the service organization***

## Management’s Report	

_***NO***_*** scope limitation permitted in report***
**Mgmt must conclude if ICFR **_**effective or not effective**_** based on extent of scope limitation**

**Notes:**
FAQ #19 – What if management does not have the ability

## Management’s Report

_***EXCEPTIONS ( SEC FAQ 1, 2, 3)***_
**FAQ 1 – FIN 46 – entity in existence prior to 12/15/03**
**FAQ 2 – equity method investments**
**FAQ 3 – acquisitions – 1 yr max.**

## Required Communications

***Mgmt must communicate all ***_***significant deficiencies***_*** & ***_***material weaknesses***_*** they detect to audit committee & external auditor***
**Part of 302 certification**
***Mgmt also must provide written representations to auditor***

## SEC FAQs

***23 FAQ’s***
***Updated October 6, 2004***
_***[www.sec.gov/info/accountants/controlfaq1004.htm](http://www.sec.gov/info/accountants/controlfaq1004.htm)***_
***PCAOB also issued 3 separate sets of Staff Q&As (39)***
**June 23, 2004**
**October 6, 2004**
**November 22, 2004**

## SEC FAQs

_***Scope Limitations – Questions 1–3***_
***FAQ 1 – consolidated VIEs, proportionate consolidations***
**What is the meaning of “does not have the right or authority to assess”?**
**Neither legal rights nor ability of mgmt to remediate deficiencies are necessarily tied to mgmt’s ability to assess ICFR**
**Facts and circumstances will dictate when mgmt has the ability**

## SEC FAQs

***FAQ 2- Equity investee***
**Not intended to prohibit registrants from assessing ICFR of investees under the equity method**

## SEC FAQs

***FAQ 3 – Recent business acquisition***
**Intent of issuing FAQ 3 is not to negatively impact mgmt’s business decisions**
**Will likely not object to anyone who decides to use this relief in the year of acquisition**
**“****Business” as defined in EITF 98-3 or Article 11 of S-X**** **

## SEC FAQs

***FAQ 4 – Conclusion that ICFR is ***_***not effective***_
**Registrant will still be considered timely & current re: **
**Rule 144, S-2/S-3/S-8 eligibility**

## SEC FAQs	

***FAQ 9 – Disclosure of changes to ICFR made in preparation of 1******st****** Mgmt report***
**Giving relief for the 302 requirement to disclose material changes in ICFR**
**HOWEVER.....**
**If change is driven from material weakness, notwithstanding the relief that is being given, registrants should carefully consider disclosing the material weakness and the resulting changes**

## SEC FAQs

***Other most frequent:***
***FAQ 8 –   Transition reports***
***FAQ 14 – SAS 70 reports***
***FAQ 21 – Consents***
***FAQ 22 – Annual “glossy” reports***
***FAQ 23 – Supplementary information***

## Other Questions

***IPO -Initial 404 assessment ***
**Due with first annual report**
**once effective date passes**
***Discontinued operations not finalized as of end of year***
**No relief**

## Other Questions

***Registrants in Chapter 11***
**No automatic exemption from 404**
**If registrant qualifies for modified reporting under SLB 2 then registrant does not need to comply with 404**
**Must request relief in advance**

## What we are seeing

***Significant deficiencies & material weaknesses identified are being disclosed in Form 8-K and Form 10-Q***
***Typical areas where significant deficiencies/material weaknesses have been identified:***
**Personnel issues**
**Financial systems**
**Restatements due to lack of controls**

**Notes:**
These include IT weaknesses or poor procedures, as well as things as basic as inadequate or poorly trained staff

## Final Remarks

***We know there will be material weaknesses***
_**Key is disclosure**_
**What the problem is**
**What it impacts**
**How are you going to remediate**
**Timetable for remediation**

## Use of Other Auditors

_***EXAMPLE***_***:***
***U.S. auditor relies on work of foreign audit firm to perform work on foreign subs of registrant***
***U.S. firm chooses not to place reliance on work of other audit firm (i.e. no reference to other auditor)***

## Use of Other Auditors

***Foreign firm must be registered with PCAOB if:***
**Performing a “substantial portion of the audit”**
***Foreign firm must be “recognized” by SEC***

## Use of Other Auditors

***“******Recognition” of Foreign Firm***
***Registration with PCAOB does not supercede ******existing means by which a firm demonstrates its qualifications to practice before the SEC****** ***
**US affiliation and Appendix K compliance **
**Demonstration to OCA of knowledge and experience of applying U.S. GAAP, PCAOB standards, SEC rules and SEC independence requirements**

## Use of Other Auditors	

_***Other Questions***_***:***
***What if U.S. firm uses local persons as independent contractors?***
**i.e., Individuals, not firms**
***Is the U.S. firm required to travel to the foreign location as part of the audit?***

## Other Auditor Issues

***Licensing Requirements***
***Have seen instances where auditor is not licensed in the state or country where principal audit procedures were conducted***
**Problematic in certain instances**
**Addressing on case-by-case basis**
**Contact DCF with questions on real life fact patterns**

***BREAK***

## Financial Reporting and Disclosure

**Tagged Data Initiative**
**Joel Levine**

## Tagged Data Initiative

**Concept release**** – **
***Use of tagged data to facilitate timely and accurate financial analysis.***
**  **

## Tagged Data Initiative

***Possible benefits from tagged data:***
**Information that is tagged can be searched, retrieved, and analyzed by automated means.**
**Reduces time, cost and errors commonly associated with manual information collection and analysis.**

## Tagged Data Initiative

**Rule proposal –**
***Voluntary program allowing registrants to furnish financial information in XBRL format.***

## Concept Release

**Concept release sought comment on:**
**Adequacy of XBRL format and technologies.**
**Types of information to be tagged.**
**Sufficiency of standard taxonomies.**

## Concept Release 

**A taxonomy is a list of standard financial reporting elements (terms) with their definitions and other information.  These elements may be tagged with:**
**Monetary values**
**Text – words or labels**

## Concept Release

**Concept release also sought comment on:**
**Commission’s role in development and maintenance of standard taxonomies.**
**Impact on investors, registrants, and accountants.**

## Concept Release

**Comment period ended Nov. 15th:**
**XBRL standard is generally sufficient for tagging financial information.**
**Technical complexity of XBRL.**
**Eventually, a broader range of information in filings could be tagged (e.g., MD&A, industry guide data, loan covenants, and officer compensation).**

## Concept Release

**(Continued)**
**Taxonomies should be developed and maintained by the private sector, subject to public review and comment and Commission oversight.**
**Impact on investors – quicker data consumption allowing more time for substantive financial analytics. **

## Concept Release

**(Continued)**
**Impact on registrants – need to learn data tagging concepts and software tools; consider taxonomy extensions; after startup, tagging effort should be nominal and routine.**
**Impact on accountants – potential for enhanced financial analysis, risk assessments, and internal control testing once XBRL is integrated into accounting systems and audit tools are developed.**

## Concept Release

***(Continued)***
**Auditor attestation of tagged data:**
**Will build investor confidence in reliability of tagged data.**
**AICPA Interpretation No. 5 of SSAE No. 10 (AT Section 101):             *****“Attest Engagements on Financial Information Included in XBRL Instance Documents”***** currently provides sufficient guidance.**

## Voluntary Program

**Registrants would tag their financial information in XBRL format using a US GAAP standard taxonomy*****:***
**Investment Management**
**Insurance**
**Banking and Savings Institutions**
**Commercial and Industrial**

## Voluntary Program

**Regarding the XBRL documents:***** ***
**Supplemental to official filing.  Exhibit 100 to Exchange Act or Investment Company Act filings.**
**Furnished rather than “filed.”**
**Include in initial filing, an amendment, or an 8-K (6-K for foreign private issuers).**
**Information consistent with official filing.**

## Voluntary Program

***  *****(Continued)**
**Excluded from Section 302 certifications.**
**No audit opinions or review reports.**
**Label data unaudited (unreviewed).**
**Volunteers could start and end their participation at any time; may submit XBRL data regularly or from time to time.**

## Voluntary Program

**No stated end date.  If adopted, after some period of time we may:**
**Leave voluntary program in place indefinitely, change one or more features in the program, or terminate the program.**

## Voluntary Program

**Rule proposal sought comment on:**
**Is there a better way to test XBRL?**
**Should we permit tagging of less than a complete set of financial statements?**
**Concerns about company extensions?**
**Eliminate 8-K or 6-K filing options?**
**Should mgmt. certify XBRL data?**
**Should auditors attest to XBRL data?**
**How to assess usefulness of the data?**

## Voluntary Program

**Comment period ended Nov. 1st:**
**Generally supportive of voluntary program and proposed features.**
**Standard taxonomies thought to be sufficiently developed for purposes of the program.**
**Software tools may prove challenging to use in their current state.**

## Voluntary Program

**All comment letters we received are available on our website:**
_***[www.sec.gov](http://www.sec.gov/)***_
**Under “Regulatory Actions.”**

## Tagged Data Initiative

**What we’re doing:**
**Learning more about XBRL.**
**Evaluating comments received.**
**Determining appropriate form of adopting release.**
**Developing internal capabilities to receive and analyze XBRL formatted data.**

## Financial Reporting and Disclosure

** ****Statement of Cash Flows and Long-Term Customer Receivables**
** ****Private-equity valuation**
** ****Non-GAAP Managed Basis Measures**
** ****Dividend Policy Disclosures**
**Todd E. Hardiman**

## Statement of Cash FlowsL/T Customer Receivables

***Are the cash flow effects of customer receivables operating or investing cash flows?***

## Statement of Cash FlowsL/T Customer Receivables

_***Paragraph 22a of Statement 95:***_
**22. Cash inflows from operating activities are:**
**a. Cash receipts from sales of goods or services, including receipts from collection or sale of accounts, and both short- and long-term notes receivable from customers arising from those sales.**

## Statement of Cash FlowsL/T Customer Receivables

_***Paragraph 16a of Statement 95:***_
**16. Cash inflows from investing activities are:**
**a. Receipts from collections or sales of loans made by the enterprise and of other entities’ debt instruments (other than cash equivalents, certain debt instruments that are acquired specifically for resale as discussed in Statement 102, and securities classified as trading securities as discussed in Statement 115) that were purchased by the enterprise.**

## Statement of Cash FlowsL/T Customer Receivables

_***Statement 95 deliberations:***_
**Explicit consideration of Installment Sales**
**Exposure Draft - split presentation**
**Final standard – ALL cash flows from inventory sales are operating cash flows**

## Statement of Cash FlowsL/T Customer Receivables

_***Effect of Statement 102***_*** - ******Statement of Cash Flows – Exemption of Certain Enterprises and Classification of Cash Flows from Certain Securities Acquired for Resale***
**Are cash flows of a financial institution’s  trading account and similar items, such as loans acquired for resale, **_***similar to***_*** *****inventory*****?***

## Statement of Cash FlowsL/T Customer Receivables

_***Example - Captive Finance Subsidiary ***_
***Assumptions:***
**Registrant (Parent) sells Product A for $10**
**Customer pays no cash**
**Captive finance sub issues loan to customer for $10 and remits $10 to Parent**

## Statement of Cash FlowsL/T Customer Receivables

_***Example - Captive Finance Sub., continued***_
_***Stand-alone Parent perspective:***_
**Operating cash inflow of $10**
_***Stand-alone Sub perspective:***_
**Investing cash outflow of $10**
_***Consolidated entity perspective:***_
**Non-cash transaction**

## Statement of Cash FlowsL/T Customer Receivables

_***Example - Captive Finance Sub., continued***_
**Conclusions:**
***Consolidated entity perspective***
***Analogies to EITF 85-12 not persuasive***
***ALL Cash flows from sale of inventory are operating cash flows regardless if***
***Collection from customer or sale to others***
***On account or in form of a note or loan***
***Short-term or long-term***

## Financial Reporting and Disclosure

***Valuation of Privately-Held-Company Equity Securities Issued as Compensation***
*** ******(VPES or “Cheap Stock”)***

## VPES or “Cheap Stock”

_***Circumstances***_
**No Quoted Market Prices**
**No Recent Sales of the Same or a Similar Company Security**
_***Valuation Methodologies***_
**Generally, Two Step Approach**
***Enterprise Value Determination***
***Enterprise Value Allocation (if Multiple Equity Classes)***

## VPES or “Cheap Stock”

_***Theme #1***_***: The Approach Used to ***_***Determine***_*** Enterprise Value Must be Appropriate for the Company’s Stage of Development***
***Stages of Development ***
***No revenue/founder’s capital***
***Initiate product development/Outside financing***
***Achieve product development milestones***
***Saleable product***
***Operating profitability***
***Sustained Operations***

## VPES or “Cheap Stock”

_***Theme #1***_***: - continued***
***Three Broad Approaches to Determine Enterprise Value***
***Market Approach***
***Income Approach***
***Asset-Based Approach***

## VPES or “Cheap Stock”

_***Theme #1***_***: ******- continued***
_**Observation**_**:**
**Asset-based approach likely not appropriate for IPO reporting periods**

## VPES or “Cheap Stock”

_***Theme #2***_***:  The Method Used to ***_***Allocate ***_***Enterprise Value Must be Appropriate for the Company’s Stage of Development***
***Required if Multiple Classes of Stock***
***Three Broad Methods***
***Probability-Weighted Expected Return Method***
***Possible Future Outcomes might include IPO, Remaining Private, Merger or Sale, Dissolution***
***Option-Pricing Method***
***Current-Value Method***

## VPES or “Cheap Stock”

_***Theme #2***_***:  -continued***
***Two Trends in IPO Filing Reviews***
***Use of Current Value Allocation Method***
***Averaging Allocation Methods***

## VPES or “Cheap Stock”

_***Theme #2***_*** - continued***
***Use of Current Value Allocation Method***
_**Observation:**_
**Current-Value method likely not appropriate for IPO reporting periods**

## VPES or “Cheap Stock”

_***Theme #2***_*** - continued***
***Averaging Allocation Methods***
_**Observations:**_
**Select the allocation method that is most appropriate for the circumstances**
**Averaging disparate results of different allocation methods may not be appropriate**

## VPES or “Cheap Stock”

_***Theme #3***_***:  Discounts***
**Objective and Reliable Support Needed**
**Appropriateness of:**
*** ***_***Type***_*** of Discount***
***Lack of Control Discount***
***Disproportionate Returns?***

## VPES or “Cheap Stock”

_***Theme #3***_***:  Discounts - continued***
**Appropriateness of:**
_***Magnitude***_*** of Discount***
***No Bright Lines***
***Burden on Management***
***Sufficient Objective Support***
***Facts and Circumstances of Entity***

## Financial Reporting and Disclosure

***Non-GAAP Managed-Basis Measures***

## Non-GAAP Managed-Basis Measures

***Financial Institutions and Retailing Companies***
**Remove sale treatment of loan and receivable securitizations accounted for as sales**
***Non-Financial Institutions***
**Include revenue of businesses managed on behalf of others**

## Non-GAAP Managed-Basis Measures

_***Non-Financial Institutions***_
_***System Wide Revenues***_
**Frequently calculated as**
**Registrant’s revenues    +**
**Managed entities revenue – **
**Registrant’s management fees**
**Appropriate or prohibited?**

## Non-GAAP Managed-Basis Measures

_***Financial Institutions and Retailing Companies***_
**Managed Basis Measures**
***Remove Effects of Securitization Accounted for as Sales = Non-GAAP Measure***
***Consistency with Management’s Approach?***
***Comparability vs. Normalize?***

## Non-GAAP Managed-Basis Measures

_***Financial Institutions and Retailing Companies***_
**Disclosures required by Statement 140**
***Not a Non-GAAP Measure***
***Goal is to Highlight Sources of Risk and Benefit Stemming from Retained Interest***

## Financial Reporting and Disclosure

***Management’s Statement of Intent to Pay Future Dividends***
***and the Need for***
***Dividend Policy Disclosures ***

## Dividend Policy Disclosures

***Income Deposit Security (IDS)***
**Yield =**
**Coupon on Debt**
***plus***
_***Intended Dividend***_
_***Equal to Cash in Excess of Operating Needs***_
***Paid quarterly***

## Dividend Policy Disclosures

_***Why Focus on Disclosures about Intended Dividends?***_
**Significance**
**Company**
**Assumes Best Use of Excess Cash is Payout to Shareholders, Not Reinvestment in Business**
**Marketing**
**Contrast to equity IPO where return on investment stems primarily from stock appreciation**

## Dividend Policy Disclosures

_***Why Focus on Disclosures about Intended Dividends?***_
**Discretionary**
**No Contractual Obligation to Pay **
**Different from REITs – Not Obligated by Tax Code to Pay Out Most of their Cash**
**Board Discretion as to Timing and Amount (can be $0), regardless of policy**
**Shareholder has No Contractual Demand Right **
**Lack of Precedent**

## Dividend Policy Disclosures

_***Key Elements of Disclosure***_***:***
**Clear articulation of what the dividend policy will be, how the company arrived at it, and how they expect to be able to pay it**
**Identification of Risks and Limitations**
**Inclusion of Forward-looking information to support ability to pay intended dividends **
**Analysis - Liquidity and Capital Resources**
***Note: ***_***Not***_*** a One-Size Fits All Model: address specific facts and circumstances***

## Dividend Policy Disclosures

_***Risks and Limitations***_*** – (clearly disclose them)***
**Discretionary**
**Intended policy can be modified/revoked at any time **
**Dividends may not be paid in accordance with policy**
**Limitations imposed by debt covenants and state laws**
**Consequences of no invest. in future growth **
**Assumes ability to refinance debt when due **
**No provision for unexpected cash needs**
**Impact of adverse tax outcomes, if any**
**Impact of subordination clauses, if any, when multiple classes of stock**

## Dividend Policy Disclosures

_***Forward-looking info***_*** - ******(include in filing)***
**Must support the assertion registrant will have **_**cash**_** necessary to pay the intended dividends **
**Intended dividends policy should not be stated for periods in excess of period supported by expected future cash flows (for example, next 12 months)**

## Dividend Policy Disclosures

_***Forward-looking info***_*** - ******(include in filing)***
**Balance Forward-Looking “estimated cash available” with comparable Historical Amounts of “cash available”**
**Identify Differences from Historical Amounts – perhaps**
**Increased costs due to being public**
**Increased interest expense (Income Deposit Sec.)**
**Changes in levels of capital expenditures**
**Explain why mgt. believes they can pay intended dividend if historical amounts indicate otherwise**
**Identify need, if any, to borrow to pay dividends**

## Dividend Policy Disclosures

_***Forward-looking info***_*** - (include in filing)***
**Detailed Assumptions used in forward-looking info.**
**Bullet point list of assumptions and any changes from historical amounts is an acceptable presentation**
**Discuss risks and possible outcomes if expected results are not achieved**
**State whether mgt. expects company to be in compliance with debt covenants based on forward-looking operating results and expected cash flows**

## Dividend Policy Disclosures

*** ***_***MD&A -Liquidity and Capital Resources***_
**Intended dividend policy for the next year, and how they intend to fund it (e.g., cash from operations or borrowings/credit facility)**
**Assumptions re: Cash available for dividends **
**Effect of new securities and financing agreements, if any**
**Increased interest expense**
**Effect of paying out cash as dividends rather than retaining for expansion and reinvestment in the business**

## Conclusion

**Questions and Answers**

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