Elmer R. Easton
Three D Graphics, Inc.
Los Angeles, CA 90064
310 231 3330 x311
August 2003

Reporting Companies Beware: SOX 409 Will Knock Your Socks Off

The Sarbanes-Oxley Act of 2002, an Act " To protect Investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes"

The advent of the Sarbanes-Oxley Act (waggishly known as the Accountants Health & Welfare Act of 2002) is seen by many as an exercise in checklist conformance. Others claim it to be another government intrusion in the practice of free enterprise. And still others laud it as an Enron-accelerated effort by the Feds (to wit, the SEC) to foster corporate truth-in-telling. Yet even Mr. Sarbanes and Mr. Oxley can't quite agree upon its ultimate interpretation, intent and value (WSJ 7.24.03).

But most agree with its potential impact as an extension to the Act of '33 and the Exchange Act of '34. As such, it is viewed as a wakeup call, no matter the scope of compliance. And that is the key word: Compliance. It appears that almost every major accounting company, business intelligence software purveyor and consulting organization is viewing Sarbanes-Oxley ("SOX") "compliance" as a new trough upon which to feed, fueled by their clients' fear of non-compliance retribution.

And the fear is well founded! But not for ignorance or non-compliance with the issues stressed by these current suppliers. True: It is important to respect the dozens of caveats concerning outside auditor "musts" and "Musts-not", internal audit committee composition and responsibility, and the Section 404-prescribed auditor certification of internal controls. Granted that the CEO and CFO can no longer claim ignorance of financial malfeasance and must attest to the accuracy of the published reports -- 10Q, 10K and 8K, accordingly.

The fear has to do with Title IV Section 409. And well it should! Consider the pertinent opening words of the Act: "To protect investors by improving the accuracy and reliability of corporate disclosures ..." Then consider that an investor in a particular security makes a decision every day whether or not to continue to own that security. There is scant comfort, from an investment decision perspective, to know that a company has complied with the voluminous check list or has satisfactory internal controls or that which is published is accurate.

So therefore consider, out of eleven Titles with sixty three Sections, only one Section - number 409, exhorts a company (called the "Issuer") to provide the kind of information suited to an investment decision. Depending on whether you are an investor or an Issuer, SOX 409 is a "sweet spot" or a "smoking gun". And perched on the sidelines is the Strike Bar, sensing the fresh meat incident to material non-compliance. And that's enough to knock your socks off!

To make the point, it is necessary to examine and interpret Section 409, to parse it line by line, partially rearranged for emphasis:

· "Each issuer ... shall disclose to the public on a rapid and current basis such additional information concerning material changes in the financial condition or operations of the issuer ..."

The operative words are "rapid" and "current" and "material", all subject to interpretation. Rapid and current mean that it behooves a company to fashion ("model") its reporting financials in a manner that material changes can be readily incorporated.

Material means information that could affect an investor's decision to "keep", "buy" or "sell". Simply put: "In which direction do the company's fortune appear directed."

  • "... in plain English, ..."

Unusual words for an act of congress. (Not the only place in the Act for unusual words. In another section, WorldCom is cited as an example of malfeasance). Nevertheless, the intent is clear: "No fancy legal or accounting jargon, please!"

  • "... include trend ... information ..."

This may be the heart of the disclosure regimen. "However things went before - the last 12 months, the last 8 quarters, the last five years - will it continue looking forward?"
A simple question; a not so simple answer - given the requirement for outside auditor confirmation. There is always a trend looking back, even if it is barely measurable or replete with anomalies. If the answer is "yes", what are the qualifications? After all, if revenue or profits have increased (or costs decreased) by a particular percentage or amount in the past five years, will it continue at the same pace indefinitely, or change in a specific matter or ...?

And if the answer is "no", which may mean that "things will be better", the why and the when are pertinent. This brings us back to the requirement for a "model" designed to determine these answers, quickly and simply.

  • "... include qualitative information ..."

If trend is the heart of disclosure, qualitative is the soul. The dictionary definition: "The degree or grade of excellence". The likely SOX definition: "The optimum future performance, positive and negative". And still again, a relevant model will be an invaluable tool, particularly if it takes into account the relevant bounds and constraints.

  • " ... include graphic presentations ..."

Graphs and charts are a common component of annual and sometimes quarterly reports. They don't accompany 10K and 10Q documents, retrievable from Edgar On-line, et al. But when they are provided, their design is hardly ever sufficient to properly determine trends, and if used by an investor for this purpose, it can lead to improper conclusions.

On the other hand, charts and graphs of various natures could be a feature of or accompaniment to the trend analysis described earlier. They could show corrections for anomalies; they could show potential projections for the future; they could show "what if ..."; they could show "quality", they could show bounds and constraints related to specific contributing items or variables. They could be a powerful tool for an investor's deliberative process.

  • "... [all] as necessary or useful for the protection of investors ...."

This sums it up nicely and reverts to the opening statement of the Act and this discourse.

And why this discourse? A recent edition of the Los Angeles Times featured a front page and multi-column subsequent page article on the Sarbanes-Oxley Act. Albeit 50 or so column inches, it missed the point. A panoply of similar writings by analysts and potential compliance tool purveyors has similarly failed.

It isn't just the Enrons and World Coms that concerns the authors, it's the dozens and dozens of securities whose prices reached dizzying heights before reality set in. Wishful thinking substituted for rational analysis. The only problem is that the average investor, as well as the "professional", never received enough information - if indeed that information was generated or available - with which to make such an analysis.

So not withstanding its 64+ pages, eleven Titles and sixty three Sections, the purpose of SOX is exemplified in barely eight lines in one Section (409) of one Title (IV). For this is the only place in the entire Act, with all its caveats and entreaties, that validates its primary raison d'etre: the protection of the ordinary investor.

It's worth repeating: The ordinary investor who would like to be prudent investor, needs to know, "in plain English", how is "my company" doing? Will it or may it or can it make more or less or the same amount of money in the future? The investor isn't seeking conclusions, but enough information to make its own conclusions.

For the purpose fundamentally intended, the check list compliance and other aspects of the sixty remaining sections are a nicety. "Is my stock going to go up or down" and "Give me enough honest information to make an educated assessment" are the necessities.

And that's why failure to comply with SOX 409 may be enough to knock your socks off!

ACUMEN Financial Solutions, Inc.
a subsidiary of Three D Graphics, Inc.

July 2003

ACUMEN/Sarbanes-Oxley Summary Specification


The Sarbanes-Oxley Act of 2002 (the "Act") is a blueprint in need of a blueprint. Whereas certain elements of "compliance" are straight forward and can be "check list" determined, others are fuzzy at best and are contributive to a software feeding frenzy of unusual (and probably unanticipated) proportion.

Issuers, the designation in the Act given to reporting companies that have issued registered stock, are exhorted throughout the Act to conduct their financial life in ways which "... fairly present in all material aspects the financial condition and results of operations ... for the period represented in the report". That is no change from the past.

But Title IV Enhanced Financial Disclosures, Section 409 Real Time Issuer Disclosures is both a change and a challenge:

"Each issuer reporting under section 13(a) or 15(d) of the Securities Exchange Act of 1934 shall disclose to the public on a rapid and current basis such additional information concerning material in the financial condition or operations of the issuer, in plain English, which may include trend and qualitative information and graphic presentations, as the Commission determines, by rule, is necessary or useful for the protection of investors and in the public interest."

ACUMEN/SOA is a set of tools designed to aid issuers meet, auditors confirm and analysts pontificate upon the new disclosure challenge.



A fundamental premise of ACUMEN/SOA is that a company must know itself before it can make itself known to its investors and the public at large. The fundamental premise is that issuers can/may no longer fool its investors and the public (Global Crossing is cited in the Act as an example.) Conversely, companies can ill afford to fool themselves.

As later detailed, ACUMEN/SOA is a tool set that will enable an issuer to both examine itself and to comply - in a timely manner - with the following mandated disclosure requirements:

  • Meaningful trend analysis

  • Practical Optimization of Resources

  • Management alerts to "out of bounds" conditions

  • Management alerts to "red flag" operations

  • Quantitative measure of strategic options

  • Graphical presentations of any or all of the above

  • Timely response in reporting material changes [the ease of determining the effect of material changes is another feature of ACUMEN/SOA.]


ACUMEN/SOA is a tool set specifically tailored to enable disclosure compliance, financial and operational, at every level of a corporate hierarchical structure. Following are certain of the major elements:

  • Meaningful Trend Analysis. Operational Data from any number of historical periods (e.g. months, quarters, years) is automatically entered. The mathematical trend, calculated by any of a number of methods, is automatically determined for each of the "root" (i.e. independent) variables/accounts, and in one key stroke is extended to an equal population period going forward. Each such trend can be graphically represented and readily adjusted to account for historical anomalies and perceived "going forward" constraints, both for the purpose of determining a realistic "growth factor". The result is an Operating Plan (sometimes called a Forecast). At the end of each period, the Actual is automatically entered (and thus sometimes described as a Rolling Forecast), therefore facilitating a Plan in comparison with Actual. Any number of other comparisons are readily determined. The ability to "inject reality" with respect to determining a forward growth factor, quickly and easily, is the characteristic that distinguishes ACUMEN/SOA from other trend analysis solutions.

  • Practical Optimization of Resources. ACUMEN/SOA provides the means to analyze each organizational and operational variable/account in terms of its minimum and maximum practical value and, taken together, calculate the optimum configuration or arrangement of the resources they represent. Any specific resource relationship may be linear, piecewise linear or non-linear. In this respect, selling price is a resource; purchase price is a resource; marketing cost is a resource; space is a resource; facilities is a resource; any ratio covenant is a resource; borrowing limit is a resource - all by of examples.

  • Management Alerts to Out of Bounds Conditions. Once a range is established for a specific variable/account, independent or dependent, the user is automatically alerted to calculated values that fall outside this range. The user is invited to either extend the range or be satisfied with the "best solution" that can be obtained within the range. These options can be extended through the automatic generation of a "sensitivity analysis", a multi-variable table that responds to the result of user-defined incremental changes in a specific variable.

  • Management Alerts to Red Flag Operations. At the User's option, the visual range of any variable can be partitioned in two to five color-coded zones to reflect "quality". Red for unacceptable, yellow for marginal, green for acceptable. (cash, for example, may have five zones to acknowledge too much as well as too little; another may have two zones, red and green, to reflect a binary situation). ACUMEN/SOA can be programmed to alert the user when any calculated value falls within the "red zone", or at any specified value regardless of zone.

  • Quantitative Measure of Strategic Options. The ACUMEN/SOA tool, with its constraints-driven "what if" capability, is suited to exploring a wide range of transactional options. It, together with certain other features, satisfies many aspects of the Sarbanes quest to have corporations "... fairly present, in all material respects, the financial condition and results of operations ... for the period represented in the report."

  • Graphical Presentations of Any or All of the Above. To a degree not enjoyed by any other responder, ACUMEN/SOA - by virtue of its Three D Graphics roots - permits the issuer to provide a wide spectrum of interactive graphical presentations. As the graphics partner to many of the most prominent purveyors of business intelligence, the Company's prominence in this technology is unexcelled.

Typical Responses

The ACUMEN/SOA disclosure tools are just that - tools to facilitate an inward analysis and outward dissemination. Examples of such analysis and dissemination are as follows:

  1. Looking immediately back (at both the Operating Statement and the Balance Sheet), what would have been the current result if certain key financial circumstances had been different. By way of example:

    - depreciation technique, amortization of Good Will, asset impairment, interest cost rate, one- time expenses, one-time credits, one-time events, EBITDA vs. GAAP, ProForma vs. GAAP, stock options as an expense (or not), market conditions, etc. [this can easily be customized to a specific client situation]

  2. Looking at past periods, the extent to which certain key past trends continued or didn't continue, (and if so why), to the current period.

  3. Looking forward, the extent to which the past trends are expected, and if not expected why, to continue in the immediate future and longer term.

  4. Looking forward, the extent to which results may be different as a function of the effect of changes, in amount or interpretation, of certain key financial factors.

  5. Looking forward, the extent to which end goals can be accomplished as a function of the contributing financial factors, particularly in light of the practical limitations in the minimum and maximum values of these factors.

  6. The effect of limits [in the numerical range] of certain key financial factors. By way of example:

     -  borrowing limits, restrictive covenants, space, facilities, personnel, revenue, costs of a particular nature, environmental matters, legislative matters, patent and trademark matters, etc. [again, this can be customized]

And, in turn, following is an excerpt from a "hypothetical" MD&A (Management Discussion & Analysis) with the kinds of information envisioned by the SOA framers and followers:

"Operations for the quarter were generally in accordance with expectations. Factors which affected or influenced the results were as follows:

  • Profit increased by 10% due to no longer having to amortize good will.

  • Profit decreased by 5% due to recording the expense of stock options.

  • Profit would have decreased by 12% if the effect of a one time gain was eliminated.

  • Profit would have increased by 15% if we could have reduced the cost of certain raw materials.

  • Sales were lower by 20% than expected as an extrapolation of the past eight quarter trend.

  • Marketing expenses also did not follow the past trend due to an unusual one-time advertising blitz.

  • Other results generally conformed to the extension of past trends.

"Looking forward, we may reasonably expect the following:

  • Although we will still not have to amortize good will, if the profit expected from our acquisition of the ABC Company does not meet the purchase expectations, it may be necessary to record an asset impairment that could affect our profit by as much as 25%.

  • In projecting the Sales trend forward for the next eight quarters, we may have to level off after four quarters due to space and equipment limitations. Acquiring more space and equipment may be inhibited by the effect of short term borrowings on our present bank loan covenants. We have determined that it will be necessary to increase our long term debt by 35% to meet the cash requirements and still stay within the dictated ratios.

  • Given the purchase of the additional facilities necessary to meet our Sales goals, the selection of amortization method, given the latest tax law changes in this respect, could substantially affect our reported results. We are determining the range of potential effects and will be able to report accordingly after the planning has reached fruition.

  • Not withstanding the theoretical result of an extension of the previous eight quarter profit trend to the end of eight quarters looking forward, the optimal result may be 15% lower than calculated after giving due attention to the practical limitations (i.e. the minimums or maximums, as the case may be) to the "variables" that will directly and indirectly contribute to this result.

  • We have carefully analyzed and made a quality assessment of the factors ("variables") that collectively make up the Company's financial statements. We have identified those that qualify as "acceptable", those that are "marginal" and those that are "poor". Every effort is being made to "upgrade" the quality of those factors that don't meet our evaluation criteria.

  • We have embraced the concept of "Practical Optimization of Resources" in setting the key performance goals. This means that with respect, for example, to establishing pertinent revenue, cost and profit goals, we have determined their optimum values, after giving appropriate consideration to the bounds or constraints in the individual and collective values of the contributing elements.

"The `what if' and `what could have been' looking back, and `what is reasonably expected to be, given the limitations and constraints' looking forward, reflect Management's current best estimates including the interpretation and extrapolation of past trends (suitably conditioned to discount anomalies) of future operations. As expressed in the "Safe Harbor" declaration elsewhere in this report, there are no certainties."

Special Note

There is no question that being "more forthcoming" and "fairly presenting" in public announcements is tricky business. True appreciation of the combined continuous contact with shareholders (particularly institutional) large and small, analysts, bankers and regulators is perhaps reserved to those who have run public companies.

Nevertheless, that proverbial cat is out of the bag. Reporting on "trends", "qualitative and quantitative analysis", "forward looking expectations" and "graphical presentation" are here to stay. The ACUMEN/SOA Solution, as an addition to a Business Intelligence purveyors Financial Reporting product, provides technical excellence coupled with an exceptional ease of use by the non-technical professional. A profit-positive combination. Good examples of the non-technical professional are the CFO, the CEO and individual profit center managers. So even though the ACUMEN/SOA calculations are precise, the ranges (bounds, limits) that frame the what-if, and particularly bottom-up, results may be largely subjective and must be easy to manipulate.