A reporting company's methods of accounting are already prescribed by a regulation issued under another federal statute. How does Section 13(b)(1) of the Exchange Act limit the Commission's rules for that company's Exchange Act reports on the same subject matter?

They prevail over it, the Exchange Act's reporting rules taking precedence over any accounting method another federal law prescribes

They may not be inconsistent with that requirement, unless the Commission determines that the public interest or investor protection requires it

They may not be inconsistent with it in any circumstances, the other statute's requirement binding the Commission without exception

They may differ from it only where the company elects in its report to follow the Commission's method and discloses the difference

A Regulation S-X requirement calls for information on a subject to be furnished where it is material. Under Rule 1-02, how does the word material limit what must be furnished?

To matters a prudent management would treat as significant to its own business decisions

To items exceeding a fixed percentage of the registrant's total assets or net income

To matters that would change the auditor's opinion on the statements taken as a whole

A registrant has never adopted a closing date for its annual accounting period. What is its fiscal year for the purposes of Regulation S-X?

The calendar year, which ends on December 31

The twelve months ending at its first filing date

The twelve months ending with its latest quarter

The fiscal year that its parent company has adopted

An independent accountant concludes that an overall opinion on a registrant's financial statements cannot be expressed. Can the document setting out that conclusion still be an accountant's report as Regulation S-X Rule 1-02 defines the term?

No: the definition covers only a document that expresses an opinion on the financial statements taken as a whole, whatever its stated scope

Yes: the definition covers a document stating the scope of the audit and asserting that an overall opinion cannot be expressed

No: a document without an opinion is treated as a review report, which falls outside the accountant's report definition altogether

Yes, but only where the accountant also gives a separate opinion on each individual statement within the set it examined

A domestic registrant files financial statements that depart from generally accepted accounting principles in measuring one class of assets, and a detailed footnote explains the departure and quantifies its effect. No Commission provision permits the departure. How does Rule 4-01(a)(1) of Regulation S-X treat the statements?

They are presumed misleading only if the registrant's independent auditor has declined to concur with the departure

They are accepted, since a footnote that quantifies the effect of a departure satisfies the rule's disclosure condition

They are presumed misleading or inaccurate, notwithstanding the footnote that discloses and quantifies the departure

They are accepted for this filing, provided the statements in the registrant's next annual report conform to the principles

A registrant's financial statements comply in every respect with generally accepted accounting principles but leave out a disclosure that an article of Regulation S-X specifically requires. Does compliance with those principles satisfy Rule 4-01?

No, but only where including the omitted disclosure would have changed the net income reported for the period

Yes: statements prepared under generally accepted principles are presumed by the rule to be complete and accurate

Yes, unless the Commission's staff issues a comment letter asking the registrant to add the omitted disclosure

No: Regulation S-X specifies certain disclosures that must be included in any event, alongside the accounting principles

A registrant presents the money amounts in its financial statements in thousands of dollars rather than whole dollars. What does Rule 4-01(b) of Regulation S-X require of that presentation?

An indication that amounts are in thousands, placed beneath the caption, atop the money columns or in narrative material

Nothing further, amounts expressed in multiples of dollars needing no indication where used consistently across periods

A reconciliation in the notes of each rounded total to its whole-dollar equivalent, so that readers can trace every figure

Prior clearance from the Commission's staff, whole dollars being the only unit the rule permits without such clearance

A private standard setting body seeking recognition under Securities Act Section 19(b) has trustees who left registered public accounting firms eighteen months before joining its board. How does the statute treat those trustees in applying its majority condition?

As independent trustees, the condition looking only at association with such a firm during a trustee's service

As associated persons, the condition reaching anyone associated with such a firm in the two years before service

As independent trustees once they have divested any financial interest they held in their former firms

As associated persons only until two years have passed since they left their former firms, and as independent trustees thereafter

Among the conditions Securities Act Section 19(b) sets for a standard setting body whose principles the Commission may recognize, what must the body have adopted to deal with emerging accounting issues?

Procedures delegating emerging issues to its trustees, who may amend principles without any vote of its members

Procedures requiring the Commission's prior approval before any change to its principles is published for comment

Procedures ensuring prompt consideration, by majority vote of its members, of the changes those issues make necessary

Procedures requiring unanimous agreement among its members before any principle may be changed or withdrawn

A private standard setting body meets every organizational, funding and procedural condition in Securities Act Section 19(b)(1)(A). What further condition must be satisfied before the Commission may recognize its principles as generally accepted?

An endorsement by the Public Company Accounting Oversight Board that its standards can be audited against in practice by registered firms

An approving vote by the national securities exchanges on which the registrants that would use its principles are listed

Ratification of its existing body of accounting principles by Congress, through a joint resolution passed by both of its chambers

A Commission determination that it can assist the Commission, being at minimum capable of improving financial reporting and investor protection

What must a standard setting body recognized under Securities Act Section 19(b) submit each year, and to whom?

An annual report containing its own audited financial statements, to the Commission and to the public

An annual report on its agenda and completed projects, to the Commission alone and without financial statements

Its unaudited budget and staffing figures, to the congressional committees that oversee the Commission's work

The audited financial statements of the issuers that fund it, to the Public Company Accounting Oversight Board

After Section 109 of the Sarbanes-Oxley Act took over the funding of the recognized private-sector accounting standard setter, what responsibility did the Commission's 2003 policy statement say the standard setter's parent foundation kept?

Raising voluntary contributions from accounting firms to cover any shortfall left by the statutory funding

The fee requests, which include setting the standard setter's budget each year for the Commission to review

Collecting the support fee from each issuer directly and remitting any surplus it holds to the Treasury

Fixing the amount of the fee each issuer pays, a figure that the Commission has no part in reviewing

After Section 108 of the Sarbanes-Oxley Act let the Commission recognize a private body's accounting principles as generally accepted, what did the Act provide about the Commission's own authority to establish accounting principles?

That it is confined to investment companies, the recognized body's standards governing every other registrant

That it may be exercised only after the recognized body has first declined to address the same matter itself

That nothing in the Act impairs or limits it, where the principles are established for enforcing the securities laws

That it passes to the Public Company Accounting Oversight Board for any accounting standards that are used in public company audits

What did Section 108 of the Sarbanes-Oxley Act require the Commission to study?

Adoption of a single rules-based codification, including how long retiring principles-based guidance would take

Whether to require domestic issuers to replace generally accepted accounting principles with international standards, and how quickly

Whether to merge the recognized private-sector standard setter into the Public Company Accounting Oversight Board, and on what timetable

Adoption of a principles-based accounting system, including how long a change from rules-based reporting would take

Following the Commission's 2003 determination that the private-sector standard setter and its parent foundation met the Section 108 criteria, what were registrants required to do?

Continue to comply with that body's standards in preparing their filed financial statements, unless the Commission directs otherwise

Choose between that body's standards and the Commission's own accounting rules, disclosing the choice made in their notes

Restate their prior financial statements under that body's standards within two fiscal years of the Commission's determination

Apply that body's standards only for fiscal years beginning after the determination, earlier years staying on the old basis

When the private-sector accounting standard setter was formed in 1973, long before Section 108 existed, on what basis did the Commission treat its pronouncements as authoritative?

A federal statute requiring the Commission to accept as authoritative whichever body the accounting profession designated

The Commission's own policy, recognizing them as authoritative in the absence of any contrary determination by it

A Commission rule adopting each pronouncement individually after notice of proposed rulemaking and a period for public comment

A five-year contract between the Commission and the foundation, renewable on the foundation's application each time

How did the Commission characterize its 2003 policy statement on the private-sector accounting standard setter for the purposes of the Administrative Procedure Act?

As a legislative rule adopted after notice and comment, binding until amended by later rulemaking

As an interim final rule, effective at once but open to public comment for a fixed period afterwards

As an interpretive rule that took effect only on its publication in the Code of Federal Regulations

When the foundation that oversees the recognized private-sector accounting standard setter intends to appoint a new member of either body, what did the Commission's 2003 policy statement expect?

A public comment period on the candidate, with the final choice made by a vote of the registrants that fund it

The Commission's formal approval of the candidate, without which the appointment cannot take effect at all

Nothing, appointments being an internal matter on which the Commission said it would express no view

Timely notice to and discussion with the Commission, the foundation making the final choice after considering its views

Under the Commission's 2003 policy statement, what is the private-sector accounting standard setter expected to do when it concludes that it cannot resolve an issue the Commission's staff referred to it within a time frame acceptable to the Commission?

Notify the Commission or its staff promptly, give its views on a resolution, and work with the staff to protect investors

Resolve the issue regardless by an interim standard, the policy statement leaving it no power to set a referred issue aside

Pass the issue to the Public Company Accounting Oversight Board, which then issues the guidance in its place

Take no further action, the issue reverting to the staff, which then resolves it without seeking any input from it

How far does the Commission's 2003 policy statement say the Commission and its staff control the agenda and the conclusions of the private-sector accounting standard setter?

They approve its agenda in advance each year, and it may take up a topic only once the staff has referred that topic to it

They neither bar it from other topics nor dictate the outcome of its projects, so long as its conclusions serve investor protection

They set the conclusions of the projects the staff refers to it, while leaving all other topics to its own independent judgment

They review each proposed standard before exposure and may veto one that conflicts with guidance the staff has already given

When may registrants rely on a consensus reached by the Emerging Issues Task Force in preparing financial statements that purport to conform to generally accepted accounting principles?

Only after the Commission's staff has republished it in the form of a Staff Accounting Bulletin

As soon as a majority of the Task Force's members has voted for it, no further approval being needed

Once the private-sector standard setter has ratified it and it has been published in the Task Force's minutes

Only after it has been written into Regulation S-X through a Commission rulemaking proceeding

Exchange Act Section 13(b)(2)(A) requires a reporting issuer's books, records and accounts to reflect its transactions accurately and fairly in reasonable detail. By what measure does Section 13(b)(7) fix the level of detail that is reasonable?

The level that removes every misstatement, however small or immaterial, from the issuer's books

The level a prudent independent auditor would need in order to give an unqualified opinion on the statements

The level that the issuer's own management judges adequate for its internal reporting and budgeting

A reporting issuer's controls ensure that inventory transactions are authorized by management and recorded promptly and accurately, and that only authorized staff can reach the warehouse. The controls never compare the quantities in the records with the inventory on hand. Which objective of Exchange Act Section 13(b)(2)(B) does the system fail to meet?

Comparing recorded accountability for assets with existing assets at reasonable intervals and acting on differences

Recording transactions as necessary to permit preparation of the issuer's financial statements for each period

An issuer subject to Exchange Act Section 13(b)(2) lawfully prepares its filed financial statements under an accounting framework other than U.S. GAAP. To what criteria must its internal accounting controls ensure transactions are recorded so that its statements can be prepared?

To U.S. GAAP in every case, the books having to support GAAP statements whatever framework it files under

To that other framework, the provision reaching GAAP or any other criteria applicable to the statements

To whichever framework the issuer's independent auditor selects at the start of the audit engagement

To the federal income tax rules, the books being kept chiefly to support the issuer's tax returns

A reporting issuer holds 40 percent of the voting power of a foreign manufacturer. It presses the manufacturer's board, as far as is reasonable given its stake and local law, to adopt internal accounting controls consistent with Exchange Act Section 13(b)(2), but the board declines. How does the statute treat the issuer?

It is not in breach for the present, but becomes so if the manufacturer still lacks the controls at its next fiscal year-end

It is not in breach, provided it discloses the manufacturer's lack of such controls in its next annual report

It is not in breach, being conclusively presumed to have complied once it shows good-faith efforts to use its influence

It is not in breach, provided the Commission gives written consent to the manufacturer's existing arrangements

A reporting issuer's books fail to reflect a series of transactions accurately because of a clerical error that no one noticed. What criminal liability does Exchange Act Section 13(b) attach to that failure?

None, the statute reserving criminal liability for inaccuracies material to the issuer's published financial statements

None, the statute reserving criminal liability for the officers who certify the issuer's periodic reports to the Commission

None, the statute reserving criminal liability for failures the Commission has already ordered the issuer to correct

None, the statute reserving criminal liability for knowing circumvention, failure to implement controls or falsification

Under the Commission's 2007 IFRS release, what is the effect on a foreign private issuer's filing when its auditor's report contains a qualification relating to the statements' compliance with IFRS as issued by the International Accounting Standards Board?

None, a qualification in the auditor's report going to the audit alone and leaving the issuer's option to omit the reconciliation intact

The issuer must provide a reconciliation to U.S. GAAP, the qualification taking away the option to omit it

The issuer must refile its statements under U.S. GAAP, IFRS statements being barred once an auditor has qualified them

The issuer must obtain a second auditor's opinion, which then replaces the qualified report

A foreign private issuer omits the U.S. GAAP reconciliation from its annual IFRS financial statements under the Commission's 2007 release and must also file statements for a required interim period. On what condition may those interim statements also omit the reconciliation and the interim disclosure of Article 10 of Regulation S-X?

That they are accompanied by a narrative summary of the main differences from U.S. GAAP

That they are audited to the same standard as the issuer's annual financial statements for the year

That they fully comply with IAS 34, the international standard governing interim financial reporting

That the issuer's home regulator has already accepted them in a filing made under its own rules

A foreign private issuer is preparing IFRS financial statements for the first time. How does General Instruction G of Form 20-F, after the Commission's 2007 IFRS release, treat the number of years of statements it must present?

It may present one year rather than three, until it has filed three annual reports prepared under IFRS

It must present three years as usual, the two-year accommodation having lapsed after the 2005 European transition

It may present two years rather than three, but only if it first adopted IFRS for its 2005 financial year

It may present two years rather than three, an accommodation now available indefinitely to every first-time adopter

Accounting: Who Makes and Enforces U.S. Accounting Rules for Securities Issuers

What Is Accounting, and Who Makes and Enforces the Accounting Rules for U.S. Securities Issuers?

Accounting is the discipline of recording an entity's transactions, classifying them and summarizing them in financial statements that show what the entity owns and owes, what it earned and how its cash moved. For a private business, the choice of accounting methods is largely a matter for its owners, its lenders and the tax authorities. For an issuer that sells securities to the public in the United States, accounting is also a regulated activity. Federal securities law gives the Securities and Exchange Commission authority over the methods used to prepare the accounts that registrants file, a private-sector board writes the standards the Commission recognizes as generally accepted, Regulation S-X fixes the form and content of the statements, and the Securities Exchange Act of 1934 requires reporting companies to keep accurate books and maintain internal accounting controls.

Accounting and Financial Reporting in Brief

Every transaction an issuer enters into changes at least two of its accounts, and the books record each change so that the accounts remain in balance. From those books the issuer prepares its financial statements: a balance sheet showing assets, liabilities and equity at a date, a statement of income or earnings for a period, and a statement of cash flows. The federal securities statutes themselves speak of the balance sheet and the earning or earnings statement when they describe what the Commission may regulate.

The Commission's Statutory Authority Over Issuer Accounting

Section 19(a) of the Securities Act of 1933 authorizes the Commission to define accounting terms and to prescribe the form of required information, the items shown in the balance sheet and earning statement, and the methods followed in preparing accounts, including valuation, depreciation and depletion, and consolidated statements.

Section 13(b)(1) of the Securities Exchange Act of 1934 gives the Commission a parallel power over the reports filed under that Act, covering separate as well as consolidated balance sheets and income accounts. It carries a qualification of its own. Where the methods of accounting of a reporting person are already prescribed under another law of the United States, or a rule under such a law, the Commission's rules for reports may not be inconsistent with those requirements on the same subject matter. The Commission may depart from that limit only to the extent it determines that the public interest or the protection of investors requires the inconsistency.

In its 2003 policy statement the Commission described these provisions as giving it broad authority and responsibility to prescribe accounting methods and the form and content of filed financial statements, and said that the securities laws clearly give it authority to set accounting standards for public companies and other entities that file financial statements with it.

Regulation S-X and Its Defined Terms

Regulation S-X, Part 210 of Title 17 of the Code of Federal Regulations, sets out the form and content of, and the requirements for, financial statements filed under the Securities Act, the Exchange Act, the Investment Company Act and the Investment Advisers Act. Rule 1-02 defines the terms used throughout the regulation, and several of those definitions decide how much an issuer must disclose.

The term material, when it qualifies a requirement to furnish information about a subject, confines the information required to matters about which an average prudent investor ought reasonably to be informed. The term fiscal year means the annual accounting period, and if no closing date has been adopted it means the calendar year ending on December 31. An accountant's report is a document in which an independent public or certified public accountant states the scope of the audit made and sets out an opinion on the financial statements taken as a whole, or else asserts that an overall opinion cannot be expressed.

Some definitions are borrowed rather than written afresh. The term related parties is used in Regulation S-X as it is defined in the Master Glossary of the FASB Accounting Standards Codification, so the regulation and the private-sector standards use one meaning. For the financial statements of issuers as defined in the Sarbanes-Oxley Act, an audit means an examination by an independent accountant under the standards of the Public Company Accounting Oversight Board.

The GAAP Presumption in Rule 4-01

Rule 4-01(a) of Regulation S-X requires financial statements to be filed in the form and order, and with the generally accepted terminology, that will best indicate their significance and character. The information the rules require is a minimum: the filer must add whatever further material information is needed to keep the required statements from being misleading in light of the circumstances.

Rule 4-01(a)(1) states the central presumption. Financial statements filed with the Commission that are not prepared in accordance with generally accepted accounting principles are presumed to be misleading or inaccurate, and footnotes or other disclosures do not overcome that presumption. Only the Commission can displace it, by providing otherwise. The same paragraph adds that Regulation S-X clarifies certain disclosures that must be included in any event, so statements that follow generally accepted principles in every respect can still be incomplete if they omit a disclosure the regulation itself requires.

Rule 4-01 also settles two points of presentation. Money amounts may be shown in whole dollars or in multiples of dollars such as thousands, but a statement that uses multiples must say so immediately beneath the caption of the statement or schedule, at the top of the money columns, or at a suitable point in narrative material. Negative amounts must be shown in a way that clearly distinguishes them as negative.

Section 19(b): Criteria for Recognizing a Standard Setter

Section 108 of the Sarbanes-Oxley Act of 2002 added subsection 19(b) to the Securities Act. It provides that, in carrying out its authority under Section 19(a) and under Section 13(b) of the Exchange Act, the Commission may recognize as generally accepted for the purposes of the securities laws the accounting principles established by a standard setting body that meets statutory criteria. The power is permissive: the statute says the Commission may recognize such a body, not that it must.

The body must be organized as a private entity. For administrative and operational purposes it must have a board of trustees, or an equivalent body, serving in the public interest, a majority of whom are not associated persons of any registered public accounting firm while they serve and have not been during the two years before their service. It must be funded as Section 109 of the Sarbanes-Oxley Act provides. It must have adopted procedures ensuring prompt consideration, by majority vote of its members, of changes to accounting principles needed to reflect emerging accounting issues and changing business practices. In adopting principles it must consider the need to keep standards current with the business environment and the extent to which international convergence on high quality standards is necessary or appropriate for the public interest and the protection of investors.

A further condition rests on a judgment by the Commission itself. The Commission must determine that the body has the capacity to assist it in fulfilling the requirements of Section 19(a) and Section 13(b), because, at a minimum, the body is capable of improving the accuracy and effectiveness of financial reporting and the protection of investors under the securities laws.

Accountability and Funding of a Recognized Standard Setter

Section 19(b)(2) requires a recognized standard setting body to submit an annual report to the Commission and to the public, and that report must contain the body's own audited financial statements.

Funding comes through the Exchange Act. Section 13(b)(2)(C) requires every issuer with a class of securities registered under Section 12, and every issuer required to file reports under Section 15(d), to pay its allocable share of a reasonable annual accounting support fee determined under Section 109 of the Sarbanes-Oxley Act, notwithstanding any other provision of law.

The Commission's 2003 policy statement described how that funding changed the private foundation's role. The Section 109 funding provisions replace the foundation's own funding responsibilities, but the foundation remains responsible for the fee requests, which includes establishing the standard setter's budget each year for review by the Commission. Where inadequate staffing or resources hamper the timeliness of standard setting, the Commission said it would review requests for budget increases under the procedures of Section 109(e). The Commission also said that it was recognizing the standard setter in anticipation of, and with the expectation of, Section 109 funding arriving in the near term, so that the standard setter could begin working with the Public Company Accounting Oversight Board to put the funding mechanism in place.

What Section 108 Left With the Commission

Section 108 directed the Commission to make whatever rules it considers necessary or appropriate in the public interest or for the protection of investors to carry out Section 19(b). It then preserved the Commission's own position: nothing in the Sarbanes-Oxley Act, including Section 108 and the amendment it made, is to be construed to impair or limit the Commission's authority to establish accounting principles or standards for purposes of enforcing the securities laws.

The Commission read the statute the same way in 2003. It said that the Act does not restrict its ability to develop accounting principles on its own and does not limit the number of private-sector bodies it may recognize.

Section 108 also ordered a study. The Commission was to examine the adoption by the United States financial reporting system of a principles-based accounting system, covering the extent to which principles-based accounting already existed in the United States, the length of time a change from a rules-based to a principles-based system would take, the feasibility of and methods for implementing such a system, and a thorough economic analysis of implementation. The report was due within one year of July 30, 2002.

The 2003 Policy Statement Recognizing the FASB

On April 25, 2003 the Commission issued a policy statement, Release No. 33-8221, determining that the Financial Accounting Standards Board and its parent organization, the Financial Accounting Foundation, satisfy the Section 108 criteria. As a result the Board's financial accounting and reporting standards are recognized as generally accepted for purposes of the federal securities laws, and registrants must continue to comply with them in preparing financial statements filed with the Commission unless the Commission directs otherwise.

The statement updated Accounting Series Release No. 150 of December 20, 1973, in which the Commission had expressed its intent to continue to look to the private sector, through the Board, for leadership in establishing and improving accounting principles. When the Board was formed in 1973, the Commission had recognized its pronouncements as authoritative in the absence of any contrary determination by the Commission. Before 2003, then, recognition rested on the Commission's own policy; after Section 108 it rested on a determination that the statutory criteria were met.

The determination was conditional on performance. It was premised on an expectation that the Board and any organization affiliated with it would address the issues the statement raised and continue to serve investors and protect the public interest. The Commission said it would monitor the Board's procedures, qualifications, capabilities, activities and results, and would revise the statement if the foundation or the Board no longer met the statutory criteria or the expectations it had set out. The Commission also explained that the statement was not an agency rule requiring notice of proposed rulemaking, public participation and prior publication under the Administrative Procedure Act, so the Regulatory Flexibility Act did not apply to it either.

How the Foundation and the Board Are Organized

The Financial Accounting Foundation is made up of independent trustees and is responsible for overseeing and funding the Board, appointing its members and selecting the members of an advisory body. The Commission was informed in 2003 that a majority of the trustees were not, and had not been in the two years before their service, associated with a public accounting firm, which matched the trustee condition in Section 19(b).

The Board is the body responsible for promulgating financial accounting and reporting standards. At the time of the policy statement it had seven members with expertise in accounting and financial reporting. Members were generally appointed for five-year terms and could be reappointed to one additional term and served as full-time employees of the foundation.

The Commission asked for a voice in appointments without taking them over. It said that the foundation and the Board should give it timely notice of, and discuss with it, the foundation's intention to appoint a new member of either body. The foundation makes the final determination on who is selected, but the Commission said it would provide its views and that the foundation should consider them.

Commission Oversight and the Board's Independence

The policy statement set out a working division between the Commission and the Board. The Commission's staff refers issues to the Board, or to an affiliated organization such as the Emerging Issues Task Force, when they may warrant new standards, amendments or formal interpretations, and the Board is expected to address them in a timely manner. If the Board decides that taking up an issue is not advisable, or that it cannot resolve the issue within a time frame acceptable to the Commission, it is expected to notify the Commission or its staff promptly, give its views on an appropriate resolution, and work with the staff to protect investors from misleading or inadequate accounting.

The Commission does not prohibit the Board from addressing other topics and does not dictate the direction or outcome of specific projects, provided the Board's conclusions are in the interest of investor protection. The Commission described the Board's independence as necessary so that its standards are free from bias and carry maximum credibility. Meanwhile the Commission's staff continues to resolve specific accounting and reporting issues day to day as they arise in the filings and reports of individual registrants.

The Emerging Issues Task Force is a group of about thirteen members who generally serve part time and without compensation, drawn from accounting firms of every size, business, financial analysis and academia. Once the Board ratifies a Task Force consensus, the consensus is published as part of the Task Force's minutes and may be relied on by registrants and others in preparing financial statements that purport to conform to generally accepted accounting principles.

Books and Records Under Section 13(b)(2)(A)

Section 13(b)(2) of the Exchange Act applies to every issuer that has a class of securities registered under Section 12 and to every issuer required to file reports under Section 15(d). Its first requirement is that the issuer make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect the issuer's transactions and the dispositions of its assets.

The statute defines its own standard of precision. For the purposes of Section 13(b)(2), reasonable detail and reasonable assurances mean the level of detail and the degree of assurance that would satisfy prudent officials in the conduct of their own affairs.

The requirement is separate from the later rules requiring management to assess internal control over financial reporting each year.

Internal Accounting Controls Under Section 13(b)(2)(B)

The second requirement is that the issuer devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances of four things. Transactions must be executed in accordance with management's general or specific authorization. Transactions must be recorded as necessary both to permit preparation of financial statements in conformity with generally accepted accounting principles, or any other criteria applicable to the statements, and to maintain accountability for assets. Access to assets must be permitted only in accordance with management's general or specific authorization. And the recorded accountability for assets must be compared with the existing assets at reasonable intervals, with appropriate action taken on any differences.

A company whose records are accurate but whose controls never compare the recorded quantities of inventory or securities with what is physically on hand has not met the fourth objective, however carefully it records each transaction.

The standard throughout is reasonable assurance, measured by the prudent-official test in Section 13(b)(7), rather than a guarantee that no error or loss will ever occur.

Minority-Owned Affiliates, Criminal Liability and National Security

Section 13(b)(6) limits what the statute demands where the issuer does not control the entity concerned. If a covered issuer holds 50 percent or less of the voting power of a domestic or foreign firm, Section 13(b)(2) requires only that it proceed in good faith to use its influence, to the extent reasonable in its circumstances, to cause that firm to devise and maintain a consistent system of internal accounting controls. An issuer that demonstrates good-faith efforts to use its influence is conclusively presumed to have complied.

Sections 13(b)(4) and 13(b)(5) separate civil from criminal exposure. No criminal liability may be imposed for failing to comply with Section 13(b)(2) except as Section 13(b)(5) provides, and Section 13(b)(5) forbids any person to knowingly circumvent or knowingly fail to implement a system of internal accounting controls, or to knowingly falsify any book, record or account. An inadvertent recordkeeping failure is therefore a civil matter; a knowing one can be a crime.

Section 13(b)(3) creates a narrow exception for national security. No duty or liability under Section 13(b)(2) is imposed on a person acting in cooperation with the head of a federal department or agency responsible for national security matters, if the act was done on that head's specific, written directive issued under Presidential authority. Each directive must set out the specific facts and circumstances on which it rests, and it expires one year after issuance unless renewed in writing.

IFRS Financial Statements From Foreign Private Issuers

Rule 4-01(a)(2) treats foreign private issuers differently from domestic registrants. Their financial statements may be prepared under United States generally accepted accounting principles, under International Financial Reporting Standards as issued by the International Accounting Standards Board, or under another comprehensive set of principles if a reconciliation to United States principles and Regulation S-X of the kind specified in Item 18 of Form 20-F is filed with them, except where the applicable form provides otherwise.

The acceptance of IFRS without reconciliation came from Release No. 33-8879, dated December 21, 2007 and effective March 4, 2008. It amended Items 17 and 18 of Form 20-F, made conforming changes to Rules 1-02, 3-10 and 4-01 of Regulation S-X, Forms F-4 and S-4 and Securities Act Rule 701, and applied to financial statements for financial years ending after November 15, 2007. An issuer using the option must state explicitly and unreservedly in a note that its statements comply with IFRS as issued by the Board, and its independent auditor must opine on that compliance.

The release spelled out when the reconciliation is still required: where the statements contain deviations from IFRS as issued by the Board, where the issuer does not make the unreserved and explicit statement, where the auditor does not opine on compliance with IFRS as issued by the Board, or where the auditor's report contains any qualification relating to that compliance. An issuer that prepares its statements under a jurisdictional variation of IFRS, such as IFRS as adopted by the European Union, can still rely on the amendments if it is able to state, and does state, compliance with both the variation and IFRS as issued by the Board, and its auditor opines on compliance with both. At the time, commenters identified the only difference between the European and the Board's versions as a carve-out of hedge accounting provisions in IAS 39, used by few companies. The amendments did not extend to the Board's proposed standards for small and medium-sized entities, which were designed for entities without publicly listed debt or equity.

Interim Periods, First-Time Adopters and the Commission's International Role

The 2007 release reached beyond annual statements. A foreign private issuer relying on it may also file the financial statements for required interim periods without reconciliation to United States principles, and without providing the interim disclosure that Article 10 of Regulation S-X would otherwise call for, if those interim statements fully comply with IAS 34, the international standard on interim financial reporting.

Earlier, when the European Union required listed companies in its member states to use IFRS from their 2005 financial year, the Commission had adopted an accommodation in General Instruction G of Form 20-F allowing a foreign private issuer preparing IFRS statements for the first time to present two years of financial statements rather than three. The 2007 release extended that two-year accommodation indefinitely to every first-time adopter of IFRS as issued by the International Accounting Standards Board.

The Commission does not vote on international standards. It participates in their development mainly through the International Organization of Securities Commissions, commenting on exposure drafts of the international Board's standards and contributing to working groups, and its staff attends meetings of the International Financial Reporting Interpretations Committee as a non-voting observer on behalf of that organization. Interpretations of that committee are ratified by the international Board before they take effect.

Common Errors and Exam Traps

A frequent error is to treat the private standard setter as the source of the Commission's power over accounting. The power comes from statute, chiefly Sections 19(a) of the Securities Act and 13(b) of the Exchange Act; the Commission recognizes a private body's standards as generally accepted, and Section 108 expressly preserves the Commission's own authority to establish accounting principles for enforcement purposes.

Another is to think a careful footnote can cure a departure from generally accepted accounting principles. Rule 4-01(a)(1) presumes non-GAAP statements misleading or inaccurate despite footnote or other disclosure, unless the Commission has provided otherwise.

Acceptance of IFRS without reconciliation applies to IFRS as issued by the International Accounting Standards Board in filings by foreign private issuers, not to a national version of IFRS by itself and not to domestic registrants.

Examination Relevance and Key Takeaways

The Commission's authority over issuer accounting is statutory. Regulation S-X governs the form and content of filed financial statements, and under Rule 4-01 statements not prepared under generally accepted accounting principles are presumed misleading. Section 19(b) of the Securities Act, added by Section 108 of the Sarbanes-Oxley Act, sets the criteria a private standard setter must meet to have its standards recognized, and the Commission's 2003 policy statement found that the Financial Accounting Standards Board and the Financial Accounting Foundation met them while the Commission kept its own authority and an oversight role.

Section 13(b)(2) of the Exchange Act requires reporting issuers to keep accurate books and records and to maintain internal accounting controls meeting four objectives, with criminal liability reserved for knowing violations.