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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks Before the 2006 AICPA National Conference on Current SEC and PCAOB Developments


Louise M. Dorsey

Associate Chief Accountant, Division of Corporation Finance
U.S. Securities and Exchange Commission

Washington, D.C.
December 12, 2006

As a matter of policy, the Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the SEC staff.

Good morning. It is a pleasure to be here once again to speak at this conference. I would like to address some issues on two topics that the staff has dealt with over the last year. That is, Item 4.02 8-K reporting issues and shell company reporting requirements for updating the financial statements included in a Form 8-K or 20-F. It seems I have lucked out in the order of things for this panel, as my presentation is a bit shorter than my colleagues. Maybe the longer one's tenure at the SEC, the less said the better!!

Item 4.02 Form 8-K Issues
I'd like to first talk about some issues the staff has seen regarding Item 4.02 8-K reporting. Briefly, Item 4.02 requires timely reporting of an issuer's conclusion that its financial statements cannot be relied upon, or its auditor's conclusion that the audit report or review cannot be relied upon.

The first few slides give a quick recap of the reporting requirements for both 8-K Items 4.02(a) and (b). I am not going to go over the requirements, but keep them in mind for the rest of my comments. The 8-K is due 4 business days after the nonreliance conclusion is made or the accountant advises the company that its audit or review can no longer be relied upon. While the 8-K form requirements say that an 8-K is not required if substantially the same information was previously reported in a periodic filing, a 10-K or 10-Q, we believe that the 4.02 information is an alert to the market and prefer to see it filed on an 8-K. FAQ 1 to the CF FAQs on Form 8-K dated 11/23/04 speaks to this point.

I'd like to discuss some 4.02 8-K disclosure issues we have been seeing. The 4.02 8-K must specifically state that the financial statements or previous audit report or review can no longer be relied upon and the periods involved. We will request an amendment if the 8-K does not clearly state this. We have also seen disclosures that are unclear or too general about the underlying reasons for the nonreliance conclusion. The disclosures should be as clear and specific as possible. Not all facts necessarily would be known at the time of filing the 8-K. If that is the case, it is best practice for a company to clearly state this,and describe what relevant information is missing and when the company anticipates providing an update. If the company commenced an internal investigation, it is best practice to also disclose this. If there are multiple errors in the financial statements, the staff believes it is appropriate to describe each error separately as clearly as possible, rather than commingle the reasons for more than one error in generic terms.

For example, if errors in various different revenue items were discovered, it is best practice to disclose each major type of revenue that is in error, rather than just say that the company has discovered errors in its revenue recognition. We also believe it is best practice to explain the underlying reasons why each source of revenue was in error, and why the error was not prevented or discovered in prior periods. For example, if a company were disclosing an error in its financial statements related to revenue recognition, it is appropriate to disclose the underlying reasons for the error. Such as the company erroneously recognized revenues prior to acceptance by a customer, whether it was due to an automated systems error or an internal control failure, and why it was previously undetected. Disclose if each revenue source was understated or overstated. If the amount or a reliable range of the errors can be estimated, disclose the amount or range for each revenue error. If not, disclose that the amount can't be reasonably estimated at the time of filing.

We have also seen timing issues related to the filing of Item 4.02 8-Ks. It's important to note that the trigger event is the decision that the financial statements are unreliable, not the completion of the restatement process. The key to the timing of filing an Item 4.02(a) 8-K rests upon who has the authority to make the decision. It may take more time if the Board or Audit Committee must ultimately make the nonreliance decision rather than if an authorized officer alone can make the decision.

If a company files a 4.02 8-K on the same day it files an amended periodic report to restate its financial statements, it is highly likely that the staff would question the timing of the 8-K filing. Generally, the staff believes it is unlikely that a nonreliance conclusion and the filing of restated financial statements can happen within 4 days of one another. Similarly, the staff may also question the timing of an 8-K filing where the lapse time between the 8-K and filing restated financial statements appears too short based on the nature of the restatement, as the restatement process usually takes a bit of time to work through.

The staff may question the adequacy of the disclosures in a 4.02 8-K if a company later files restated financial statements that include restatement for additional material items that were not disclosed in the 4.02 8-K. We would expect a company to be able to support why they did not disclose the additional restatement items in the original 8-K or an amended 8-K, and why the company believes the 8-K fully complied with the requirement to disclose the facts underlying the nonreliance conclusion.

An Item 4.02 8-K is not automatically required for every error in the financial statements. It would depend on a SAB 99 quantitative and qualitative analysis. That said, a company should be prepared to give a robust qualitative analysis if it is restating previously issued financial statements where the amounts of the errors are quantitatively material, either in the individual or in the aggregate. You can expect that the staff will probably question why a company has not filed a 4.02 8-K if a company files an amendment to restate its financial statements without first filing a timely 4.02 8-K. Various studies have been done regarding restatements and the filing of Item 4.02 8-Ks, such as the July 2006 GAO report. The GAO questioned why Item 4.02 8-Ks were not filed prior to all restatements. So, companies should be very careful about the timely filing of a 4.02 8-K, and be well prepared to support not filing one.

While we are on the topic of restatement and filing 4.02 8-Ks, I would like to remind you of Sondra's speech from last year, in which she provided some clarification of disclosures regarding internal controls over financial reporting in an Item 4.02 8-K. The disclosure requirements of a Form 8-K filed under Item 4.02 are focused on communicating to investors that reliance should no longer be placed on previously issued financial statements. The Form 8-K requirements are not intended to address internal controls over financial reporting. If the auditor has communicated to the registrant that a revised audit report on the registrant's internal control over financial reporting will be issued, management should determine whether the 8-K will be materially misleading if that fact is not disclosed. Additionally, management should consider whether they have a duty to correct, under Rule 12b-20, any prior misstatements in SEC reports regarding management's assessment of internal controls. In the case of a material weakness discovered in the course of a restatement, management may decide to include in the Item 4.02 8-K, a discussion of any material weakness they are now aware of due to the restatement.

Shell Company Reporting
Next, I would like to discuss reporting issues in the year of consummation of a shell company reverse merger. The shell company 8-K rules that came out in 2005 require a domestic shell company to file an 8-K within four business days of a reverse merger with an OpCo, and include all the content required by a Form 10. Foreign registrants need to file a Form 20-F for a shell reverse merger that includes all the content required by a Form 20-F, since they do not file 8-Ks.

A shell company reverse merger is considered to be like an initial registration under the 1934 Act for the OpCo accounting acquirer. As such, the financial statements of the OpCo are viewed as issuer financial statements and should be audited for all periods following PCAOB standards, not US GAAS standards. However, note that the audit firm is not required to be PCAOB registered until they issue an audit report that is dated after the consummation of the reverse merger.

This differs from a reverse merger between two operating companies where the legal acquiree is a private company. For those mergers, the legal acquiree/accounting acquirer financial statements may be audited following US GAAS because the financial statements are Regulation S-X 3-05 financial statements, not those of an issuer or a predecessor to an issuer. Of course, financial statements in 10-Ks or 10-Qs filed after the merger took place would need to be audited or reviewed following PCAOB standards for all periods, as the financial statements now are those of an issuer.

When the 8-K is filed shortly after year end or quarter end, the most recent year end or quarter end is generally not included in the financial statements. Exchange Act Rules 13a-1 and 13a-13 are designed to prevent a gap in reporting after a conventional IPO by requiring the filing of an annual or quarterly report that includes the most recent year or quarter end. Keep in mind that the basic requirement for the 8-K or 20-F is to provide all the content required by a Form 10/10SB or 20-F registration statement. Similarly, an OpCo should not have a gap in reporting after a merger with a shell company.

For illustrative purposes, assume that the OpCo qualifies as a non-accelerated filer, which normally is the case. For a domestic shell company where the acquisition 8-K is due or filed within 45 days of year or quarter-end and did not contain the latest year or quarter-end financial statements of the OpCo, the surviving company would need to file an amended 8-K to include all of the information that would be required in an annual or quarterly report for the latest year end or quarter end. This is not a Special Financial Report under Exchange Act Rule 15d-2, which includes only the latest fiscal year end financial statements that were not included in a registration statement upon effectiveness. The 8-K/A would need to include all of the content required by an annual or quarterly report. An 8-K/A filed to provide the latest year end financial statements would include two years of audited financial statements for an OpCo that qualifies for S-B reporting and three years of audited financial statements for a non-SB OpCo. All other required financial information also would be provided for the current year end. If the 8-K/A is filed to include interim financial statements for the latest quarter end, the 8-K/A would need to include the latest 3 months and year-to-date financial statements along with comparative prior period information. The interim financial information would not need to be reviewed because they are being provided in a Form 8-K, not a 10-Q. Normal '34 Act reporting would then start.

A similar scenario would apply for a Foreign Private Issuer that files an acquisition 20-F within 3 months after the latest year end. In this case, a Form 20-F/A would need to be filed to include the financial statements and other financial information for the latest fiscal year. The 20-F/A would need to be filed within 6 months of the date the acquisition 20-F is filed. Normal '34 Act reporting would then commence. Since a FPI does not file 10-Qs, the 20-F would not need to be amended to file the latest quarter end financial statements.

No certifications are required in the 8-K/A or 20-F/A because the amendment is made to file the most recent annual or quarterly financial statements of the OpCo, which was a non-issuer at the time of the original 8-K filing, to avoid a lapse in reporting. Rules 13a-14 and 15d-14 were specifically amended as part of the shell company rules to exclude certifications in 20-Fs for shell reverse mergers.

Let's go over an example. A domestic shell that is a nonaccelerated filer consummated a merger on February 6, 2006 and filed its 8-K on February 10. Both the shell registrant and OpCo have a December 31 year end. The 8-K included financial statements for the 3 years ended December 31, 2004 and 9 months ended September 30, 2005 compared to 2004. Following Rule 13a-1, the surviving company would need to file the financial statements for OpCo for the year ended 12/31/2005. The 8-K/A would include audited financial statements for the 3 years ended December 31, 2005 as well as all information required by a Form 10-K. The 8-K/A should be filed within 90 days of February 10, 2006.

Thank you for your attention this early morning. I look forward to any questions you may have, please send them up, and I will review and answer as many as I can for the Q&A session later today.


Modified: 03/19/2007