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Financial Reporting

Laws and Regulations

Preparing Financial Statements

  • The Basics

    If you can read a nutrition label or a baseball box score, you can learn to read basic financial statements. If you can follow a recipe or apply for a loan, you can learn basic accounting. The basics aren.t difficult and they aren.t rocket science.

    This brochure is designed to help you gain a basic understanding of how to read financial statements. Just as a CPR class teaches you how to perform the basics of cardiac pulmonary resuscitation, this brochure will explain how to read the basic parts of a financial statement. It will not train you to be an accountant (just as a CPR course will not make you a cardiac doctor), but it should give you the confidence to be able to look at a set of financial statements and make sense of them.

    Let.s begin by looking at what financial statements do.

    .Show me the money!.

    We all remember Cuba Gooding Jr..s immortal line from the movie Jerry Maguire, .Show me the money!. Well, that.s what financial statements do. They show you the money. They show you where a company.s money came from, where it went, and where it is now.

    There are four main financial statements. They are: (1) balance sheets; (2) income statements; (3) cash flow statements; and (4) statements of shareholders. equity. Balance sheets show what a company owns and what it owes at a fixed point in time. Income statements show how much money a company made and spent over a period of time. Cash flow statements show the exchange of money between a company and the outside world also over a period of time. The fourth financial statement, called a .statement of shareholders. equity,. shows changes in the interests of the company.s shareholders over time.

    Let.s look at each of the first three financial statements in more detail.

    Balance Sheets

    A balance sheet provides detailed information about a company.s assets, liabilities and shareholders. equity.

    Assets are things that a company owns that have value. This typically means they can either be sold or used by the company to make products or provide services that can be sold. Assets include physical property, such as plants, trucks, equipment and inventory. It also includes things that can.t be touched but nevertheless exist and have value, such as trademarks and patents. And cash itself is an asset. So are investments a company makes.

    Liabilities are amounts of money that a company owes to others. This can include all kinds of obligations, like money borrowed from a bank to launch a new product, rent for use of a building, money owed to suppliers for materials, payroll a company owes to its employees, environmental cleanup costs, or taxes owed to the government. Liabilities also include obligations to provide goods or services to customers in the future.

    Shareholders. equity is sometimes called capital or net worth. It.s the money that would be left if a company sold all of its assets and paid off all of its liabilities. This leftover money belongs to the shareholders, or the owners, of the company.


    The following formula summarizes what a balance sheet shows:

    ASSETS = LIABILITIES + SHAREHOLDERS' EQUITY

    A company's assets have to equal, or "balance," the sum of its liabilities and shareholders' equity.

    A company.s balance sheet is set up like the basic accounting equation shown above. On the left side of the balance sheet, companies list their assets. On the right side, they list their liabilities and shareholders. equity. Sometimes balance sheets show assets at the top, followed by liabilities, with shareholders. equity at the bottom.

    Assets are generally listed based on how quickly they will be converted into cash. Current assets are things a company expects to convert to cash within one year. A good example is inventory. Most companies expect to sell their inventory for cash within one year. Noncurrent assets are things a company does not expect to convert to cash within one year or that would take longer than one year to sell. Noncurrent assets include fixed assets. Fixed assets are those assets used to operate the business but that are not available for sale, such as trucks, office furniture and other property.

    Liabilities are generally listed based on their due dates. Liabilities are said to be either current or long-term. Current liabilities are obligations a company expects to pay off within the year. Long-term liabilities are obligations due more than one year away.

    Shareholders. equity is the amount owners invested in the company.s stock plus or minus the company.s earnings or losses since inception. Sometimes companies distribute earnings, instead of retaining them. These distributions are called dividends.

    A balance sheet shows a snapshot of a company.s assets, liabilities and shareholders. equity at the end of the reporting period. It does not show the flows into and out of the accounts during the period.

    Income Statements

    An income statement is a report that shows how much revenue a company earned over a specific time period (usually for a year or some portion of a year). An income statement also shows the costs and expenses associated with earning that revenue. The literal .bottom line. of the statement usually shows the company.s net earnings or losses. This tells you how much the company earned or lost over the period.

    Income statements also report earnings per share (or .EPS.). This calculation tells you how much money shareholders would receive if the company decided to distribute all of the net earnings for the period. (Companies almost never distribute all of their earnings. Usually they reinvest them in the business.)

    To understand how income statements are set up, think of them as a set of stairs. You start at the top with the total amount of sales made during the accounting period. Then you go down, one step at a time. At each step, you make a deduction for certain costs or other operating expenses associated with earning the revenue. At the bottom of the stairs, after deducting all of the expenses, you learn how much the company actually earned or lost during the accounting period. People often call this .the bottom line..

    At the top of the income statement is the total amount of money brought in from sales of products or services. This top line is often referred to as gross revenues or sales. It.s called .gross. because expenses have not been deducted from it yet. So the number is .gross. or unrefined.

    The next line is money the company doesn.t expect to collect on certain sales. This could be due, for example, to sales discounts or merchandise returns.

    When you subtract the returns and allowances from the gross revenues, you arrive at the company.s net revenues. It.s called .net. because, if you can imagine a net, these revenues are left in the net after the deductions for returns and allowances have come out.

    Moving down the stairs from the net revenue line, there are several lines that represent various kinds of operating expenses. Although these lines can be reported in various orders, the next line after net revenues typically shows the costs of the sales. This number tells you the amount of money the company spent to produce the goods or services it sold during the accounting period.

    The next line subtracts the costs of sales from the net revenues to arrive at a subtotal called .gross profit. or sometimes .gross margin.. It.s considered .gross. because there are certain expenses that haven.t been deducted from it yet.

    The next section deals with operating expenses. These are expenses that go toward supporting a company.s operations for a given period . for example, salaries of administrative personnel and costs of researching new products. Marketing expenses are another example. Operating expenses are different from .costs of sales,. which were deducted above, because operating expenses cannot be linked directly to the production of the products or services being sold.

    Depreciation is also deducted from gross profit. Depreciation takes into account the wear and tear on some assets, such as machinery, tools and furniture, which are used over the long term. Companies spread the cost of these assets over the periods they are used. This process of spreading these costs is called depreciation or amortization. The .charge. for using these assets during the period is a fraction of the original cost of the assets.

    After all operating expenses are deducted from gross profit, you arrive at operating profit before interest and income tax expenses. This is often called .income from operations..

    Next companies must account for interest income and interest expense. Interest income is the money companies make from keeping their cash in interest-bearing savings accounts, money market funds and the like. On the other hand, interest expense is the money companies paid in interest for money they borrow. Some income statements show interest income and interest expense separately. Some income statements combine the two numbers. The interest income and expense are then added or subtracted from the operating profits to arrive at operating profit before income tax.

    Finally, income tax is deducted and you arrive at the bottom line: net profit or net losses. (Net profit is also called net income or net earnings.) This tells you how much the company actually earned or lost during the accounting period. Did the company make a profit or did it lose money?

    Earnings Per Share or EPS

    Most income statements include a calculation of earnings per share or EPS. This calculation tells you how much money shareholders would receive for each share of stock they own if the company distributed all of its net income for the period.

    To calculate EPS, you take the total net income and divide it by the number of outstanding shares of the company.

    Cash Flow Statements

    Cash flow statements report a company.s inflows and outflows of cash. This is important because a company needs to have enough cash on hand to pay its expenses and purchase assets. While an income statement can tell you whether a company made a profit, a cash flow statement can tell you whether the company generated cash.

    A cash flow statement shows changes over time rather than absolute dollar amounts at a point in time. It uses and reorders the information from a company.s balance sheet and income statement.

    The bottom line of the cash flow statement shows the net increase or decrease in cash for the period. Generally, cash flow statements are divided into three main parts. Each part reviews the cash flow from one of three types of activities: (1) operating activities; (2) investing activities; and (3) financing activities.

    Operating Activities

    The first part of a cash flow statement analyzes a company.s cash flow from net income or losses. For most companies, this section of the cash flow statement reconciles the net income (as shown on the income statement) to the actual cash the company received from or used in its operating activities. To do this, it adjusts net income for any non-cash items (such as adding back depreciation expenses) and adjusts for any cash that was used or provided by other operating assets and liabilities.

    Investing Activities

    The second part of a cash flow statement shows the cash flow from all investing activities, which generally include purchases or sales of long-term assets, such as property, plant and equipment, as well as investment securities. If a company buys a piece of machinery, the cash flow statement would reflect this activity as a cash outflow from investing activities because it used cash. If the company decided to sell off some investments from an investment portfolio, the proceeds from the sales would show up as a cash inflow from investing activities because it provided cash.

    Financing Activities

    The third part of a cash flow statement shows the cash flow from all financing activities. Typical sources of cash flow include cash raised by selling stocks and bonds or borrowing from banks. Likewise, paying back a bank loan would show up as a use of cash flow.

    Read the Footnotes

    A horse called .Read The Footnotes. ran in the 2004 Kentucky Derby. He finished seventh, but if he had won, it would have been a victory for financial literacy proponents everywhere. It.s so important to read the footnotes. The footnotes to financial statements are packed with information. Here are some of the highlights:

    • Significant accounting policies and practices . Companies are required to disclose the accounting policies that are most important to the portrayal of the company.s financial condition and results. These often require management.s most difficult, subjective or complex judgments.

    • Income taxes . The footnotes provide detailed information about the company.s current and deferred income taxes. The information is broken down by level . federal, state, local and/or foreign, and the main items that affect the company.s effective tax rate are described.

    • Pension plans and other retirement programs . The footnotes discuss the company.s pension plans and other retirement or post-employment benefit programs. The notes contain specific information about the assets and costs of these programs, and indicate whether and by how much the plans are over- or under-funded.

    • Stock options . The notes also contain information about stock options granted to officers and employees, including the method of accounting for stock-based compensation and the effect of the method on reported results.

    Read the MD&A

    You can find a narrative explanation of a company.s financial performance in a section of the quarterly or annual report entitled, .Management.s Discussion and Analysis of Financial Condition and Results of Operations.. MD&A is management.s opportunity to provide investors with its view of the financial performance and condition of the company. It.s management.s opportunity to tell investors what the financial statements show and do not show, as well as important trends and risks that have shaped the past or are reasonably likely to shape the company.s future.

    The SEC.s rules governing MD&A require disclosure about trends, events or uncertainties known to management that would have a material impact on reported financial information. The purpose of MD&A is to provide investors with information that the company.s management believes to be necessary to an understanding of its financial condition, changes in financial condition and results of operations. It is intended to help investors to see the company through the eyes of management. It is also intended to provide context for the financial statements and information about the company.s earnings and cash flows.

    Financial Statement Ratios and Calculations

    You.ve probably heard people banter around phrases like .P/E ratio,. .current ratio. and .operating margin.. But what do these terms mean and why don.t they show up on financial statements? Listed below are just some of the many ratios that investors calculate from information on financial statements and then use to evaluate a company. As a general rule, desirable ratios vary by industry.

    • Debt-to-equity ratio compares a company.s total debt to shareholders. equity. Both of these numbers can be found on a company.s balance sheet. To calculate debt-to-equity ratio, you divide a company.s total liabilities by its shareholder equity, or
      Debt-to-Equity Ratio = Total Liabilities / Shareholders. Equity

      If a company has a debt-to-equity ratio of 2 to 1, it means that the company has two dollars of debt to every one dollar shareholders invest in the company. In other words, the company is taking on debt at twice the rate that its owners are investing in the company.

    • Inventory turnover ratio compares a company.s cost of sales on its income statement with its average inventory balance for the period. To calculate the average inventory balance for the period, look at the inventory numbers listed on the balance sheet. Take the balance listed for the period of the report and add it to the balance listed for the previous comparable period, and then divide by two. (Remember that balance sheets are snapshots in time. So the inventory balance for the previous period is the beginning balance for the current period, and the inventory balance for the current period is the ending balance.) To calculate the inventory turnover ratio, you divide a company.s cost of sales (just below the net revenues on the income statement) by the average inventory for the period, or
      Inventory Turnover Ratio = Cost of Sales / Average Inventory for the Period

      If a company has an inventory turnover ratio of 2 to 1, it means that the company.s inventory turned over twice in the reporting period.

    • Operating margin compares a company.s operating income to net revenues. Both of these numbers can be found on a company.s income statement. To calculate operating margin, you divide a company.s income from operations (before interest and income tax expenses) by its net revenues, or
      Operating Margin = Income from Operations / Net Revenues

      Operating margin is usually expressed as a percentage. It shows, for each dollar of sales, what percentage was profit.

    • P/E ratio compares a company.s common stock price with its earnings per share. To calculate a company.s P/E ratio, you divide a company.s stock price by its earnings per share, or
      P/E Ratio = Price per share / Earnings per share

      If a company.s stock is selling at $20 per share and the company is earning $2 per share, then the company.s P/E Ratio is 10 to 1. The company.s stock is selling at 10 times its earnings.

    • Working capital is the money leftover if a company paid its current liabilities (that is, its debts due within one-year of the date of the balance sheet) from its current assets.
      Working Capital = Current Assets . Current Liabilities

    Bringing It All Together

    Although this brochure discusses each financial statement separately, keep in mind that they are all related. The changes in assets and liabilities that you see on the balance sheet are also reflected in the revenues and expenses that you see on the income statement, which result in the company.s gains or losses. Cash flows provide more information about cash assets listed on a balance sheet and are related, but not equivalent, to net income shown on the income statement. And so on. No one financial statement tells the complete story. But combined, they provide very powerful information for investors. And information is the investor.s best tool when it comes to investing wisely.

  • Plain English Handbook : How to Create Clear SEC Disclosure Documents
    Provides clear and easy to follow guidance on preparing financial disclosure documents required for public companies by the SEC.
  • SEC Final Rules
    Current SEC rules governing financial reporting.

Filings and Forms (EDGAR)

Frequently Asked Questions:
EDGAR Filing of Certified Shareholder Reports by Registered Management Investment Companies

What is the SEC requiring?

On January 22, 2003, the SEC adopted rule and form amendments that require mutual funds and other registered management investment companies to file shareholder reports on new Form N-CSR and require each registered management investment company's principal executive and financial officers to certify the information contained in these reports in the manner specified by Section 302 of the Sarbanes-Oxley Act of 2002. These certified shareholder reports are designated as reports required under Sections 13(a) and 15(d) of the Securities Exchange Act of 1934. On June 5, 2003, the SEC amended Form N-CSR to add certifications required by Section 906 of the Sarbanes-Oxley Act as a required exhibit to the form.

Are registered investment companies still required to file certifications with their reports on Form N-SAR?

The certification requirement of Form N-SAR is being removed for all registered investment companies. A registered management investment company other than a small business investment company ("SBIC") that has a fiscal annual or semi-annual period ending on or before March 31, 2003, may choose either to file Form N-CSR or to continue to comply with the certification requirements of Form N-SAR for that period. A registered management investment company other than an SBIC that has a fiscal annual or semi-annual period ending on or after April 1, 2003, is required to file Form N-CSR for that period. Beginning immediately, a unit investment trust or an SBIC is no longer required to comply with the certification requirements of Form N-SAR.

Are registered investment companies still required to file reports on Form N-SAR?

Yes.

How do I file my Form N-CSR on EDGAR?

The EDGAR submission types used in connection with Form N-CSR are as follows; use the appropriate submission type according to whether the N-CSR is an annual or semi-annual report:*

Form N-CSR

Certified annual shareholder reports for management investment companies
Initial Filing
Amendments

N-CSR
N-CSR/A

Form N-CSR

Certified semi-annual shareholder reports for management investment companies
Initial Filing
Amendments

N-CSRS*
N-CSRS/A*

Rule 12b-25

Notification of inability to timely file Form N-CSR
Initial Filing
Amendments

NT-NCSR
NT-NCSR/A

*Separate submission types N-CSRS and N-CSRS/A for semi-annual report Form N-CSR filings will be available August 2003; until available, use N-CSR and N-CSR/A.

Do I still submit an EDGAR N-30D?

If you choose to continue to comply with the certification requirements of Form N-SAR for periods ending on or before March 31, 2003, you should continue to submit shareholder reports required under Rule 30e-1 on EDGAR as N-30D submissions.

Once you begin filing Form N-CSR, you will no longer submit shareholder reports on EDGAR as N-30D submissions. Instead, you will include your shareholder report as part of your N-CSR submission. It is designated as Item 1 of Form N-CSR; include it in your main EDGAR "N-CSR" or "N-CSRS" document.

What do I name my certification exhibit document contained in my N-CSR or N-CSRS EDGAR submission?

The EDGAR exhibit document for the certification under Section 302 of the Sarbanes-Oxley Act must be named EX-99.CERT.

The EDGAR exhibit document for the certification under Section 906 of the Sarbanes-Oxley Act must be named EX-99.906CERT.

If I have more than one certification for the same filing on Form N-CSR, how many EDGAR exhibit documents should I include?

All certifications under Section 302 should be included in one EX-99.CERT exhibit document in the N-CSR or N-CSRS submission on EDGAR.

All certifications under Section 906 should be included in one EX-99.906CERT exhibit document in the N-CSR or N-CSRS submission on EDGAR.

How do I attach and name my Form N-CSR certification exhibit document(s)?

Beginning August 2003, the "EX-99.CERT" and "EX-99.906CERT" exhibit document labels will be available on EDGAR pull down menus. Until then, follow these steps to label your exhibit documents:

    1. First, complete the Main Page of Submission Template 3.

    2. Next, select Document Button from Main Page.

    3. Then, add your N-CSR or N-CSRS document and select type.

    4. Add exhibit and select EX.99 from Type pull down menu.

    5. Click in type field after EX-99 and add the period (.) and the additional text, i.e., ".CERT" or ".906CERT."

I understand that for fiscal years ending on or after July 15, 2003, I may need to file a code of ethics exhibit to my annual report on Form N-CSR. What do I name a code of ethics exhibit included as part of Item 10(a) of Form N-CSR?

Include a code of ethics or amendment to a code of ethics filed under Item 10(a) of Form N-CSR in a single EDGAR exhibit named EX-99.CODE ETH.

What if I need help to make sure my exhibit document has the correct name?

Contact Filer Support at 202-942-8900 and ask to speak with someone in the technical support unit.

Should the report to shareholders and other information required by Form N-CSR be filed as an exhibit to Form N-CSR?

No. The only information that you should place in EDGAR exhibit documents are the exhibits listed in Item 10 of Form N-CSR. You should place the remaining information required by Form N-CSR, including the shareholder report, in the main EDGAR document named "N-CSR" or "N-CSRS."

Do BDC's and face-amount certificate companies have to file on Form N-CSR?

No. Business development companies and face-amount certificate companies file periodic reports on Forms 10-K and 10-Q under the Exchange Act, and they are required to comply with the certification requirements applicable to these forms.

Where do I get more information about the rules, including additional requirements for the contents of Form N-CSR?

See Release Nos. 34-47262, IC-25914 (Jan. 27, 2003), adopting Form N-CSR

Form N-CSR was amended to require disclosure of information related to audit and non-audit services provided by, and fees paid to, the auditor of the financial statements of a management investment company. For details concerning these requirements, see Release Nos. 33-8183, 34-47265, 35-27642, IC-25915, IA-2103, FR-68 (Jan. 28, 2003)

Form N-CSR was amended to require disclosure regarding proxy voting policies and procedures of closed-end management investment companies. For details concerning these requirements, see Release Nos. 33-8188, 34-47304, IC-25922 (Jan. 31, 2003)

Form N-CSR was amended to require disclosure regarding audit committees of listed registrants subject to Rule 10A-3 under the Exchange Act. For details concerning these requirements, see Release Nos. 33-8220, 34-47654, IC-26001 (Apr. 9, 2003)

Form N-CSR was amended to add the certifications required by Section 906 of the Sarbanes-Oxley Act of 2002 [18 U.S.C. 1350] as a required exhibit to reports on Form N-CSR filed under Section 13(a) or 15(d) of the Exchange Act, and to make technical changes to the Section 302 certification of Form N-CSR. For details concerning these requirements, see Release Nos. 33-8238, 34-47986; IC-26068 (June 5, 2003)

Sarbanes-Oxley (SOX)

  • Sarbanes-Oxley Section 404 : A Guide for Small Business
    Section 404 of the Sarbanes-Oxley Act requires public companies' annual reports to include the company's own assessment of internal control over financial reporting, and an auditor's attestation.
  • Sarbanes-Oxley Act FAQs
    Answers to frequently asked questions about the application of Sarbanes-Oxley to financial reporting.

    Question 1: Section 2(a)(7) of the Sarbanes-Oxley Act of 2002 (the "Act") defines an "issuer" as an "issuer (as defined in Section 3 of the Securities Exchange Act of 1934 (15 U.S.C. 78(c)), the securities of which are registered under Section 12 of that Act (15 U.S.C. 78l), or that is required to file reports under Section 15(d).." A company has offered and sold debt securities pursuant to a registration statement filed under the Securities Act of 1933, thus subjecting it to the reporting requirements of Section 15(d). The company did not register the debt securities under Section 12 of the Exchange Act of 1934. Subsequently, the company's reporting obligations have been statutorily suspended under Section 15(d) because it had fewer than 300 security holders of record at the beginning of its fiscal year. The company has not filed a Form 15 and has continued to file reports pursuant to its indenture. Is the company considered an "issuer" under the Act?

    Answer: No. Because the issuer had fewer than 300 security holders of record at the beginning of its fiscal year, the suspension is granted by statute and is not contingent on filing a Form 15. The definition of issuer applies only to issuers required to file reports. However, see Question 9 regarding these kinds of filers under Section 302 of the Act.

    Section 301

    Question 2: Will the rules relating to Section 301 apply to issuers whose securities are traded on the over-the-counter bulletin board market?

    Answer: No. Securities traded on the over-the-counter bulletin board market currently are not considered listed securities.

    Section 302

    Question 3: An issuer is filing a Form 10-K report after August 29, 2002, the date Rules 13a-14, 13a-15, 15d-14 and 15d-15 became effective, for a period ending prior to the effective date. Section V of Release No. 33-8124 provides that the certification required to be included with the report need contain only the statements set forth in paragraphs (b)(1), (2) and (3) of Exchange Act Rules 13a-14 and 15d-14. However, the instructions to Forms 10-Q, 10-QSB, 10-K, 10-KSB, 20-F and 40-F indicate that the required certification must be in the exact form set forth in the report. Must a certification filed during the transition period for a period ended before August 29th include the statements set forth in paragraphs (b)(4), (5) and (6) of Rules 13a-14 and 15d-14?

    Answer: No. Paragraphs (b)(4), (5) and (6) of Rules 13a-14 and 15d-14 need only be included for quarterly and annual reports, including transition reports, filed for periods ending after August 29, 2002.

    Question 4: Does an amended quarterly or annual report filed after August 29, 2002, the effective date of Rules 13a-14 and 15d-14, that amends a report filed prior to August 29, 2002 have to be certified?

    Answer: Yes. See note 48 of Release 33-8124. The certification need not include paragraphs (b)(4), (5) and (6) of Rules 13a-14 and 15d-14.

    Question 5: A company is filing a Form 10-Q/A for a period ending prior to the effective date of Rules 13a-14 and 15d-14. The amendment will neither contain nor amend financial statements. May the principal executive officer and principal financial officer omit paragraph 3 from the certifications?

    Answer: Yes. Since there will be no financial statements in the Form 10-Q/A, paragraph 3 may be omitted.

    Question 6: If an issuer has filed a Form 10-Q before the effective date of Rules 13a-14 and 15d-14, but needs to file an amended Form 10-Q after August 29, does the issuer need to provide the disclosure required by Item 307 of Regulation S-K?

    Answer: No.

    Question 7: Does the new Item 15 of Form 20-F apply to periods ending prior to August 29, 2002?

    Answer: Issuers must comply with Item 15(b) but not Item 15(a).

    Question 8: Does Section 302 apply to Forms 8-K filed by asset-backed issuers?

    Answer: No. Asset-Backed Issuers, as defined in Rules 13a-14(g) and 15d-14(g), do not need to file a certification with each Form 8-K. However, the certification that is filed with the Asset-Backed Issuer's Form 10-K will relate to certain Forms 8-K filed by the issuer in the preceding year. Please refer to Statement by the Staff of the Division of Corporation Finance of the Securities and Exchange Commission Regarding Compliance by Asset-Backed Issuers with Exchange Act Rules 13a-14 and 15d-14, dated August 27, 2002.

    Question 9: Is an issuer that is filing or submitting reports exclusively under Section 15(d) of the Exchange Act on a "voluntary" basis (for example, pursuant to a covenant in an indenture or similar document), due to a statutory suspension of the Section 15(d) filing obligation, subject to Rules 15d-14 and 15d-15 and the disclosure required by Item 307 of Regulations S-B and S-K?

    Answer: Yes. All companies filing or submitting reports under Section 13(a) or 15(d) must comply with those provisions whether or not a Form 15 has been filed pursuant to Rule 15d-6.

    Question 10: If only one other officer is certifying to the issuer's reports, is it permissible to revise paragraph 4 of the certification to make "other certifying officers" singular?

    Answer: Yes.

    Question 11: If an officer signs the certification without altering the wording to indicate he or she is providing the certification as principal financial officer, how will readers know whether the signatory is the principal executive officer or the principal financial officer?

    Answer: The officer should include his or her title under the signature.

    Question 12: If the same individual is both the principal executive officer and principal financial officer, must he or she sign two certifications?

    Answer: The individual may provide one certification and provide both titles underneath the signature.

    Question 13: A CEO resigned after the end of the quarter but before the filing of the upcoming Form 10-Q. The company appointed a new CEO prior to the filing. Who signs the certification?

    Answer: The new CEO because he or she is the principal executive officer at the time of the filing.

    Question 14: A company has a CEO who is resigning at the end of the year and is no longer performing the function of CEO although he is still employed with the company. In the interim, the company has another individual that is performing the functions of CEO. Can that other individual sign the certification despite the fact that the company still has another person with the CEO title?

    Answer: The person performing the function of CEO at the time of the filing should provide the certification. If it is not the person with the title of CEO, the company should disclose in the filing that the other individual is performing that function.

    Question 15: An issuer currently does not have a CEO/CFO. Who must execute the certifications required by Rules 13a-14 and 15d-14?

    Answer: As set forth in paragraph (a) of Rules 13a-14 and 15d-14, where an issuer does not have a CEO/CFO, the person or persons performing similar functions must execute the required certification.

    Question 16: Must co-principal executive officers (or co-principal financial officers) execute separate certifications or may both execute the same certification?

    Answer: Co-principal executive officers (or co-principal financial officers) should each execute separate certifications.

    Question 17: If Section 302 certifications are not included in, for example, a Form 10-K or 10-Q filing, and an amendment will be filed to include the certifications, must the entire document be re-filed or can the amendment include only the signature pages?

    Answer: Because the certification relates to the entire Form 10-K or 10-Q filing, the amendment should include the entire filing, not just the signature pages.

    Question 18: Using the same facts in question 17 above, if the amendment is not filed within the time period required for the periodic report, is the report deemed to be untimely?

    Answer: Yes. The periodic report will not be deemed timely for purposes of form eligibility and the issuer will not be deemed current until the amended periodic report containing the certification is filed.

    Question 19: A Canadian issuer is filing a Form F-10. Are certifications required because the Form F-10 incorporates prior Exchange Act filings?

    Answer: No.

    Question 20: What definition is the Commission currently using for internal controls and internal controls and procedures for financial reporting?

    Answer: In the release adopting the rules pursuant to Section 302 of the Act, the Commission noted the pre-existing concept of "internal controls" contained in Codification of Statements on Auditing Standards Section 319 ("AU Section 319"). See Release 33-8124 fn. 59 and accompanying text. In Release No. 33-8138, the Commission proposed defining "internal controls and procedures for financial reporting" by reference to AU Section 319, subject to any future modifications by the Public Company Accounting Oversight Board. Pending completion of rulemaking, the staff interprets both "internal controls and procedures for financial reporting" and "internal controls" for purposes of Exchange Act Rules 13a-14(b)(5) and (6) and 15d-14(b)(5) and (6) and Item 307 of Regulations S-B and S-K by reference to existing literature regarding generally accepted auditing standards, which would also be by reference to AU Section 319.

    Question 21: Are paragraphs (b)(5) and (b)(6) of Rules 13a-14 and 15d-14 currently operative given that there is no current requirement for evaluation of internal controls?

    Answer: Yes, these paragraphs are currently operative as to any filing relating to a period ending after August 29, 2002. See also Question 22.

    Question 22: New Exchange Act Rules 13a-14(b)(5) and (6) and 15d-14(b)(5) and (6) require an issuer's CEO and CFO to certify that:

    • He or she and the other certifying officers have disclosed, based on their most recent evaluation, to the issuer's auditors and the audit committee of the board of directors (or persons fulfilling the equivalent function):
      • All significant deficiencies in the design or operation of internal controls which could adversely affect the issuer's ability to record, process, summarize and report financial data and have identified for the issuer's auditors any material weaknesses in internal controls; and
      • Any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer's internal controls; and
    • He or she and the other certifying officers have indicated in the report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of their most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

    In addition, paragraph (b) of Item 307 of Regulations S-B and S-K requires an issuer to disclose whether or not there were significant changes in the issuer's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Is a quarterly evaluation of internal controls or internal controls and procedures for financial reporting required at this time, and if so, what are the particular standards? How should the issuer respond to Item 307(b) of Regulations S-B and S-K? How should the issuer's CEO and CFO address this situation in their certification statements?

    Answer: Although proposed amendments to Exchange Act Rules 13a-15 and 15d-15 would impose a requirement on an issuer's management to conduct an evaluation, with the participation of the issuer's CEO and CFO, of the effectiveness of the issuer's internal controls and procedures for financial reporting (See Release No. 33-8138), the Commission's rules currently do not specifically require an issuer's CEO or CFO, or the issuer itself, to conduct periodic evaluations of the issuer's internal controls or the issuer's internal controls and procedures for financial reporting. Some elements of internal controls are included in the definition of disclosure controls and procedures. There is a current evaluation requirement involving the CEO and the CFO of that portion of internal controls that is included within disclosure controls and procedures as part of the required evaluation of disclosure controls and procedures. We expect that issuers generally also would engage in an evaluation of internal controls. We believe that issuers generally currently evaluate internal controls, for example, in connection with reviewing compliance with Section 13(b) of the Exchange Act or in connection with the preparation or audit of financial statements.

    In the case of Item 307(b) of Regulations S-K and S-B, to the extent that an issuer has conducted an evaluation of its internal controls as of the end of the period covered by the report, including under the circumstances described in the preceding paragraph, the issuer should disclose any significant changes to the internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. If the issuer has made any significant changes to internal controls or in other factors that could significantly affect these controls, such changes would presumably follow some evaluation, in which case the required disclosure must be made. If the issuer has made no significant changes, then no disclosure is required. This response is also applicable to Item 15(b) of Form 20-F and Item 6(c) of Form 40-F.

    Regarding the certifications under Exchange Act Rules 13a-14(b)(5) and (6) and 15d-14(b)(5) and (6), the disclosures under Item 307 of Regulations S-B and S-K described above following any evaluations of internal controls, including in the circumstances described above in which the CEO or the CFO participates, would satisfy the requirements of paragraph (6). Paragraph (5) would currently require that disclosure be made by the CEO and the CFO to the issuer's auditors and the audit committee of its board of directors of any events enumerated in paragraph (5) that have occurred of which the CEO or CFO become aware based on the most recent evaluation of internal controls, including in the circumstances described above, in which the CEO or CFO participates.

    Question 23: For purposes of Rules 13a-14(b)(5) and (6) and 15d-14(b)(5) and (6), what do the terms "significant deficiencies" and "material weaknesses" mean?

    Answer: For purposes of Rules 13a-14(b)(5) and (6) and 15d-14(b)(5) and (6), the meaning of the terms "significant deficiencies" and "material weaknesses" should be determined by reference to generally accepted auditing standards. See generally, AU Section 325.

    Question 24: Where the registrant is a limited partnership that does not have an audit committee, who should be considered the persons performing the equivalent function as referenced in new Exchange Act Rules 13a-14(b)(5) and 15d-14(b)(5)?

    Answer: Many limited partnerships do not have audit committees. Many general partners of limited partnerships are themselves limited partnerships. In this case, look through each general partner of the limited partnerships acting as general partner until a corporate general partner or an individual general partner is reached. With respect to a corporate general partner, the registrant should look to the audit committee of the corporate general partner or to the full board of directors as fulfilling the role of the audit committee. With respect to an individual general partner, the registrant should look to the individual as fulfilling the role of the audit committee.

    Section 403

    Question 25: If a company otherwise maintains a dividend reinvestment plan that satisfies the exemptive conditions of Rule 16a-11, are automatic dividend reinvestments under a non-qualified deferred compensation plan also eligible for the Rule 16a-11 exemption, so that those reinvestment transactions would not be required to be reported, thus reducing the number of Forms 4 due?

    Answer: Non-qualified deferred compensation plans are not Excess Benefit Plans, as defined by Rule 16b-3(b)(2) under the Exchange Act, in which transactions are exempted by Rule 16b-3(c). See Interpretive Letter to American Bar Association (Feb. 10, 1999, Q. 2(c)). Under Rule 16a-3(g)(1), as amended in Release 34-46421 (Aug. 27, 2002), each transaction in a non-qualified deferred compensation plan must be reported on a Form 4 not later than the end of the second business day following the day on which the transaction was executed. However, if a company maintains a dividend reinvestment plan that satisfies the exemptive conditions of Rule 16a-11, automatic dividend reinvestments under a non-qualified deferred compensation plan are also eligible for the Rule 16a-11 exemption. See Interpretive letter to American Home Products (Dec. 15, 1992).

    Question 26: In order to reduce the number of Forms 4 due annually, an insider makes the following choices: In connection with the annual year-end election to defer some of the following year's salary into a non-qualified deferred compensation plan, the insider elects to have payroll deductions invested in the plan's interest-only account. The insider also elects for the deferred salary so invested to be "swept" on a quarterly basis into the plan's stock fund account. How should these "sweep" transactions be reported?

    Answer: Each "sweep" transaction would be reportable separately on Form 4. If the "sweep" election satisfies the Rule 16b-3(f ) exemptive conditions for Discretionary Transactions (as defined in Rule 16b-3(b)(1)), the "sweep" transactions would be reported using Code I. Further, if the reporting person does not select the date of execution for a "sweep" that is a Discretionary Transaction, Rules 16a-3(g)(3) and (4) would apply to determine the deemed execution date.

    Question 27: For purposes of satisfying the affirmative defense conditions of Rule 10b5-1(c), an insider adopts a written plan for the purchase or sale of issuer equity securities. In the plan, which was drafted by a broker-dealer, the broker-dealer specified the dates on which plan transactions will be executed. Can the insider rely on Rule 16a-3(g)(2) to compute the Form 4 due date for plan transactions based on a deemed execution date?

    Answer: No. By adopting a written plan that specifies the dates on which plan transactions will be executed, the insider will have selected the date of execution for plan transactions. Consequently, the insider will not be able to rely on Rule 16a-3(g)(2) to compute the Form 4 due date for plan transactions based on a deemed execution date.

    Question 28: When reporting more than one transaction on the same Form 4, what date should be stated in Box 4?

    Answer: The transaction date (not the deemed execution date) of the earliest transaction reported should be stated in Box 4.

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