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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks before the 2005 Thirty-Third AICPA National Conference on Current SEC and PCAOB Developments


Joel Levine

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

Washington, DC
December 6, 2005

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.

Note: You can access the slides referenced in this speech at http://www.sec.gov/news/speech/slides120605jl.pdf

Accelerated Filer Proposal

Good morning.

I'd like to begin by sharing with you highlights from a proposed rule amendment on Accelerated Filers. The comment period has ended, and we expect the Commission to take final action next week. The proposed revisions principally affect the following areas:

  • Computation of Public Float;
  • Creation of a new category of Accelerated Filer;
  • Modification of accelerated deadlines;
  • Easier ability to exit Accelerated Filer status; and,
  • New cover page disclosures.

This slide shows the conditions for meeting the definition of an "accelerated filer" - all of these must be met as of the end of the issuer's fiscal year.

  • The issuer has been subject to Section 13(a) or 15(d) of the Exchange Act for a period of at least 12 calendar months;
  • The issuer has filed at least one annual report pursuant to Section 13(a) or 15(d) of the Exchange Act;
  • The issuer is not eligible to use forms 10-KSB and10-QSB for its annual and quarterly reports; and,
  • The issuer had an aggregate worldwide market value of voting and non-voting common equity held by non-affiliates of $75 million or more, but less than $700 million, as of the last business day of the issuer's most recently completed second fiscal quarter.

The last condition describing "public float" is the one that reflects the proposed change.

  • First, the term "worldwide" will be used in defining the aggregate market value of the issuer's non-affiliated voting and non-voting common equity. This change is proposed to make the definition consistent with the staff's longstanding interpretation of the public float assessment for the Form S-3 eligibility requirements. It also will be consistent with the public float condition of a "well-known seasoned issuer," which Marty Dunn spoke about yesterday
  • The second proposed change is a new ceiling, $700 million, to the public float test in the definition of an "accelerated filer."

The obvious question is what happens if the issuer's public float is $700 million or above. Well, the proposal introduces a new category of accelerated filer, called the "large accelerated filer." It specifically defines a "large accelerated filer" as an issuer that meets all of these same conditions, except that its public float in the last bullet is at a level of $700 million or more.

This slide summarizes the proposed 10-K and 10-Q filing due dates for a non-accelerated filer, an accelerated filer, and a large accelerated filer. These accelerated deadlines would apply to companies beginning with their Form 10-K for fiscal years ending on or after December 15, 2005, and would remain in effect thereafter.

 Form 10-KForm 10-Q
Non accelerated filer90 days45 days
Accelerated filer75 days40 days
Large accelerated filer60 days 40 days

A couple of aspects to these proposals you should bear in mind if they are adopted. First, a company assesses whether it becomes an accelerated filer, or a large accelerated filer, only at its fiscal year-end. Second, the public float is always assessed only as of the end of the company's most recently completed second fiscal quarter. This also holds true for assessing whether a company ceases to be an accelerated, or large accelerated, filer. And, the first periodic filing that will be affected by a change in status can only be the Form 10-K for the year in which the assessment is made. Deadlines for filings on 10-Q for the remainder of the year in which the assessment is made will remain unchanged.

This brings me to the ever popular question, "once I qualify for accelerated filer status, how do I get out?" As you know, the existing rules require a company to remain an accelerated filer until such time that it becomes a "small business issuer." This is a very high hurdle because in order to become a small business issuer, the company's public float and its annual revenues have to be less than $25 million for two consecutive years. The proposed rule amendment eases an accelerated filer's ability to become a non-accelerated filer - simply if its public float falls below $25 million at the public float determination date. The proposed amendment also defines how a large accelerated filer may become an accelerated filer by its public float falling below $75 million. So, say a calendar-year accelerated filer determined its public float at June 30, 2005 to be less than $25 million; it would become a non-accelerated filer starting with its 12/31/05 10-K. And, that company would continue on that basis until such time that it meets the conditions to become an accelerated filer, or large accelerated filer.

Cover page disclosures. On the cover page to the Form 10-K, registrants currently disclose their second quarter-end public float and check a box indicating whether or not they meet the criteria of an accelerated filer. There's a similar box to check on the Form 10-Q. Under the proposed amendment, the check-the-box would be expanded to include "large accelerated filer" status. Also, for the first time, this check-the-box would be included on the cover page to the Form 20-F. In this regard, foreign private issuers are reminded that they are not exempt from the definition of accelerated filer, or large accelerated filer under the proposed amendment. It's just that the Form 20-F deadline has never been accelerated. So, if a foreign private issuer chooses to file on Forms 10-K and 10-Q, it must comply with the accelerated filer rules currently in place, as well as the amended rules if adopted. A word of caution to foreign private issuers who historically filed 20-Fs and then lose their foreign private issuer status - Once that status changes, the periodic reporting requirement switches immediately to 10-Ks and 10-Qs. The first filing due after Foreign Private Issuer status is lost may be a 10-Q, which may be due on an accelerated basis if the filer met the definition of an accelerated, or large accelerated filer, as of its latest year-end.

Several conforming changes to other rules also were proposed, including those reflected on this slide. The proposed rule amendment, as well as the comment letters we received, are available on our website, www.sec.gov, under Regulatory Actions.

Cash Flows Statements

Now, I'd like to take the opportunity to discuss one of the basic financial statements required under GAAP; one that is receiving more and more attention by financial analysts, rating agencies, and investors who are interested in understanding where a company gets and uses its cash. Obviously I'm referring to the Statement of Cash Flows.

The staff has been giving this Statement greater scrutiny, and it is becoming a growing source of comments, many of which have resulted in restatement. The fact that this is the second year in a row the Corp. Fin. panel is remarking on the cash flows statement should be a sign of the staff's increased emphasis on the proper classification of cash flows. At last year's conference, we spoke about reporting cash flows from installment sales financed through a captive, wholly-owned finance subsidiary. This year, I'd like to talk about the cash flow presentation for discontinued operations, dealer floor plan financing arrangements, and insurance claim proceeds. Following my presentation, Rachel Mincin will continue this theme by talking about cash flows associated with loans held for sale and beneficial interests in securitized loans.

I would encourage you to evaluate carefully how you present these items in your cash flows statement in light of the remarks we will be making this morning. It may be a good time also to take a fresh look at your cash flows statement in it entirety to make sure you are properly categorizing all cash flows - that review should cover routine as well as non-routine transactions.

Okay, starting with Discontinued Operations - we've found that registrants are reporting disc. ops. in increasing numbers, which is no surprise given FASB Statement 144's broad criteria. Because of this increased frequency, however, we've become acutely aware of a wide variety of ways in which those cash flows are being reported in the cash flow statements. Why the diversity? We know that the criteria for reporting discontinued operations under Statement 144 focuses in part on the ability to distinguish a component's operations and cash flows from the rest of the entity and on the elimination of those operations and cash flows from the ongoing operations. While the notion of identifiable cash flows is integral to the model, FAS 144 is silent with respect to reporting the cash flows associated with the discontinued operations.

Looking to the standard on cash flows, FASB Statement 95 requires that an entity report its cash inflows and outflows according to whether they relate to operating, investing, or financing activities. Footnote 10 of that Standard specifically addresses discontinued operations. It essentially reads as follows:

'Separate disclosure of cash flows pertaining to discontinued operations reflected in the operating, investing, and financing categories is not required. An enterprise that nevertheless chooses to report separately operating cash flows of discontinued operations shall do so consistently for all periods affected.'

So, perhaps the various presentations are a function of registrants interpreting this guidance differently, or registrants having different opinions as to what they believe to be the most useful and transparent display for their investors.

Recognizing that variations in cash flow presentation exist, the staff believes the key consideration is whether they conform to the basic disclosure requirement in FAS 95 that all cash flows be reported as relating to either operating, investing, or financing activities. Some of the variations that we believe are consistent with this disclosure requirement include:

  • Combining the cash flows generated from discontinued operations with the cash flows from continuing operations within each of the 3 categories;
  • Separately identifying the cash flows related to discontinued operations within each of the 3 categories; and,
  • Displaying the cash flows related to discontinued operations separately for operating, investing and financing activities near the bottom of the statement, just before "net increase or decrease in cash and cash equivalents."

We believe Statement 95 does not support aggregating operating, investing, and financing cash flows from discontinued operations into a single line item, as some registrants have presented. Also, FAS 95 does not support presenting cash flows from operating, investing, and financing activities of the discontinued operations all within the operating cash flow category.

At this juncture, I'd like to make you aware of one further shortcoming we've noticed with several of the cash flows statements. Where registrants were presenting their operating cash flows under the indirect or reconciliation method, many began that reconciliation with "income from continuing operations." Paragraph 28 of Statement 95 is clear that companies should adjust, and therefore begin with, "net income" in presenting operating cash flows under the indirect method.

It's very important for registrants to consider disclosures about their cash flows within the Liquidity and Capital Resources section of MD&A. Here, management should pay particular attention to describing how cash flows from discontinued operations are reflected in their cash flows statements, and, if material, they should quantify those cash flows if they are not separately identified in those statements. In addition, management should describe how it expects the absence of cash flows, or absence of negative cash flows, related to the discontinued operations to impact the company's future liquidity and capital resources.

Now, I'd like to spend a couple of moments discussing cash flows associated with a dealer's floor plan financing arrangements. While we identified this issue in connection with the automobile dealer industry, the concepts also would apply to other dealers who purchase under similar arrangements.

Auto dealers often finance the purchase of their inventory by engaging in floor plan financing arrangements with a finance subsidiary of the manufacturer. Just to use one particular car manufacturer for illustration, a dealer would finance the purchase of Ford products through Ford Motor Credit Company, for example. Under these arrangements, the finance subsidiary pays the manufacturer, holds a lien on the automobile, and then is repaid at a future date by the dealer. These arrangements are treated as seller financing transactions within the operating cash flow category.

So, when the dealer purchases the inventory, the purchase price is reported within operating activities as both an increase in trade loans and an increase in inventory. When the inventory is sold and the loan is repaid, the trade loan is reduced as an operating cash outflow. The end result from the purchase and sale is a net operating cash inflow for the amount of the gross profit.

The situation addressed by the staff dealt with a transaction similar to the purchase of non-Ford products financed through Ford Motor Credit Company. For example, say a dealer purchases Toyotas and Hondas financed under a floor-plan arrangement with Ford Credit. Ford Credit pays the supplier directly and then is repaid later by the dealer. In this case, the financing arrangement is not with the supplier, as it was when the dealer purchased Ford products; therefore, it does not represent a trade loan. It represents a third-party financing arrangement. Not a big deal, except that the inventory purchase, an operating activity, has taken place without the dealer physically delivering the cash. Based on the view that the financing entity effectively has acted as the dealer's agent, we concluded that upon purchase of the inventory, the dealer should report the increase in the third-party loan in substance as a financing cash inflow, with a corresponding operating cash outflow for the increase in inventory. Upon repayment, the cash outflow would be reported as a financing activity. Here, the cash flows statement would depict the substance of the transactions - with the end result being similar to the previous example where the net effect on operating cash flows is the amount of gross profit generated.

The final cash flow issue I'm going to speak about this morning deals with classifying insurance proceeds. For example, how should you classify insurance proceeds you receive from a property damage or business interruption claim? What if you planned to use the property damage proceeds to repay outstanding debt instead of replacing the property? How would you classify the proceeds under a business interruption policy that you planned to invest in new equipment or to settle litigation?

Paragraph 22c of Statement 95 basically states that proceeds of insurance settlements should be classified as operating cash inflows, except for proceeds that are directly related to investing or financing activities. It provides an example that proceeds received from the destruction of a building would be classified as investing cash inflow.

We view this guidance to mean that proceeds from insurance settlements should be classified based on the nature of the insurance coverage which gave you the right to receive payment. Said differently, classification is based on the nature of the loss that is covered by your insurance policy. Classification of the proceeds is not affected by how you spend, or plan to spend, those proceeds. So, the proceeds you received under a business interruption policy would be classified within operating activities regardless of how you planned to spend them. Classification of proceeds received under a policy that protects against damage to, or loss of, your property depends on the nature of the covered property. Recovery on fixed assets owned or leased under capital leases would be an investing activity, and settlements related to fixed assets under operating leases, as well as inventory, would be an operating activity. Again, what you do with the proceeds does not affect how you classify the cash inflow.

Another reminder about MD&A: Material cash settlements should be discussed so investors understand what you received, why you received it, what you plan to do with it, how it's been presented on the cash flows statement, and the impact on reported earnings.

This concludes my prepared remarks. Thank you.


Modified: 03/15/2006