The Securities and Exchange Commission has published a sample letter to help companies understand how they should restate their financials to correct backdated stock option grants, making good on a promise last year to help the legion of companies struggling with the problem.
In December, the SEC said it would offer guidance on a “catch-up 10-K disclosure” for companies facing the prospect of multiple restatements because of problems with improperly dated stock option grants across many years. The Commission is investigating more than 100 companies for possible wrongdoing with stock option awards, and many more are conducting their own internal probes before prosecutors do the job for them.
Posted on the SEC’s Web site by the Division of Corporation Finance, the guidance is a hypothetical letter to an oil and gas company that has inquired with the SEC about how to restate its financials. The letter outlines a series of points the Commission expects the company to include in its catch-up 10-K, from restated tables to additional Management Discussion & Analysis information explaining the errors. The guidance—1,640 words long—also warns the company that the new disclosure does not necessarily mean that the SEC will refrain from issuing a comment letter or continuing any formal investigation.
The SEC hopes that by allowing a company to make a one-time restatement of all its backdating woes—which is a departure from the usual practice of one restatement for each offending year—it can avoid a flood of questions from Corporate America and long delays in wrapping up regulatory probes.
Zuckerman
“It’s an opportunity for companies to make a single comprehensive disclosure and move forward,” says Jeffrey Zuckerman, a former SEC enforcement lawyer now at the law firm Pillsbury Winthrop Shaw Pittman. Minimizing the number of revised filings that are needed “makes sense both from the standpoint of companies that have to prepare and make them and investors who need to read and understand them,” he says.
Guidance
Below is an excerpt from the guidance recently released by the SEC on correcting misdated stock options.
We understand that you plan to restate previously issued financial statements for errors in your accounting for grants of stock options to employees, members of the board of directors, and other service providers and that you have determined that your periodic filings for multiple periods contain materially inaccurate financial statements and related disclosures...
The staff of the Division of Corporation Finance will not raise further comment regarding your company’s need to amend prior Exchange Act filings to restate financial statements and related MD&A if your company amends its most recent Form 10-K and includes in that amendment the comprehensive disclosure outlined below. If your next Form 10-K is due to be filed within two weeks of the Form 10-K amendment that you would file in response to this guidance, we will not comment on your company’s need to amend or file prior Exchange Act filings to restate financial statements and related MD&A if your company includes the comprehensive disclosure outlined below in that next Form 10-K, rather than including the comprehensive disclosure in an amendment to your most recent Form 10-K.
In taking this position, we understand that you will include the following disclosure in your Form 10-K amendment (or your next Form 10-K, as appropriate):
An explanatory note at the beginning of the Form 10-K amendment that discusses the reason for the amendment.
Selected Financial Data for the most recent five years as required by Item 301 of Regulation S-K, restated as necessary and with columns labeled “restated”.
Management’s Discussion and Analysis as required by Item 303 of Regulation S-K, based on the restated annual and quarterly financial information, explaining the company’s operating results, trends, and liquidity during each interim and annual period presented. Discussions relative to interim periods may be incorporated into the annual-period discussions or presented separately.
Audited annual financial statements for the most recent three years, restated as necessary and with columns labeled “restated”.
If interim period information for the most recent two fiscal years as required by Item 302 of Regulation S-K is required to be restated, the information presented for the balance sheets and statements of income should be in a level of detail consistent with Regulation S-X Article 10-01 (a)(2) and (3), and appropriate portions of 10-01(b) and with columns labeled “restated”. Note that there is no need to present cash flow information as it is not required by Item 302.
Footnote disclosure reconciling previously filed annual and quarterly financial information to the restated financial information, on a line-by-line basis and for each material type of error separately, within and for the periods presented in the financial statements (audited), in selected financial data, and in the interim period information (see paragraph 26 of FASB Statement No. 154).
The disclosure referred to in the Chief Accountant’s September 19, 2006 letter that applies to your restatement (click here for the letter).
Audited financial statement footnote disclosure of the nature and amount of each material type of error separately that is included in the cumulative adjustment to opening retained earnings.
Audited financial statement footnote disclosure of the restated stock compensation cost in the following manner (see complete letter, below) ...
Source
Sample Letter Sent In Response To Inquiries Related To Filing Restated Financials For Errors In Accounting For Stock Option Grants (SEC; Jan. 17, 2007)
The guidance letter follows yet another letter issued Sept. 19, 2006, by SEC Chief Accountant Conrad Hewitt to accounting-industry leaders, where Hewitt spelled out how companies should investigate whether they have a problem with historical grants and what to do if they discover one. That letter specified that companies proposing to correct material errors without amending all previously filed reports should contact the staff of the Division of Corporation Finance for further discussion—a not-so-subtle hint that the SEC expects restatements where companies discovered problems with historical grants.
Keith Bishop, a partner at the law firm Buchalter Nemer, agrees that the guidance will be helpful to issuers still in the process of reviewing historical stock option grants. But, he notes that it may come too late for many issuers that have already filed amended reports.
Bishop
“I think the guidance reflects the disclosure practices that the staff has observed in amended filings made last year,” he says. “The SEC has had a post hoc regulatory perspective. It has simply watched, waited, and provided ‘guidance’ only after the fact through enforcement or interpretive releases.”
What To Do Now
The guidance letter advises that the staff of the Division of Corporation Finance won’t raise further comment regarding a company’s need to amend prior Exchange Act filings to restate financial statements and related MD&A if the company amends its most recent Form 10-K and includes comprehensive disclosure. And if the company’s next Form 10-K is due to be filed within two weeks of the Form 10-K amendment that a company would file in response to the guidance, the SEC won’t comment on the company’s need to amend or file prior Exchange Act filings to restate financial statements and related MD&A if the company includes specified disclosure in that next Form 10-K, rather than in an amendment to its most recent Form 10-K.
“What companies need to do now is go back and read the chief accountant’s Sept. 19 letter and view it as a checklist,” Bishop says. “They ought to use it and the new guidance as a checklist as they’re doing their amended disclosures.”
Since some issuers will be dealing with historical issues that occurred more than three years ago, Bishop also warns that companies should “be careful in their analysis of their internal controls and whether they had a weakness in their most recent year.”
While the guidance creates an escape from daunting restatements, it doesn’t provide refuge from the long arm of enforcement officers.
“You should not interpret this guidance to mean that we will not review your filings if you follow it,” says the letter, signed by Carol Stacey, Division of Corporation Finance’s chief accountant. “Furthermore, as with all staff guidance, the Commission has not approved this letter or the guidance we provide in it.”
The letter also details what the guidance does not do.
It says: “In advising you that the staff of the Division of Corporation Finance will not raise further comment regarding your company’s need to amend prior Exchange Act filings to restate financial statements and related MD&A, it is important that we advise you that this guidance does not:
mean the Division of Corporation Finance will not comment on or require changes in your Form 10-K amendment or Form 10-K that includes the comprehensive disclosure we outlined above;
mean the Division of Corporation Finance has concluded that you or your company have complied with all applicable financial statement requirements;
mean the Division of Corporation Finance has concluded that the company has satisfied all rule and form eligibility standards under the Securities Act and the Exchange Act;
mean that the Division of Corporation Finance has concluded that the company is current in filing its Exchange Act reports;
mean that the Division of Corporation Finance has concluded that the company has complied with the reporting requirements of the Exchange Act;
foreclose any action recommended by the Division of Enforcement with respect to your disclosure, filings or failures to file under the Exchange Act; or
foreclose any action recommended by the Division of Enforcement under Section 304 of the Sarbanes-Oxley Act, Forfeiture of Certain Bonuses and Profits, with respect to the periods that the company’s financial statements require restatement, irrespective of whether the company amended the filings to include the restated financial statements.”
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