Reading Financial Reports for Dummies (45 page)

✓

Changes in stock exchange listing:
Any time the company gets notifica-tion that it may be
delisted
(removed) from a stock exchange, or if the company fails to meet the rules or standards set by the stock exchange it’s listed on. Any plans to change to a new stock exchange must also be reported.

✓

Accountant change:
Any change in the company’s certifying accountant.

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Unreliable financial reports:
Any conclusion by the company’s board of directors, a committee of the board, or an authorized officer that a previously issued financial report can’t be relied on for information.

You’ve probably heard press reports indicating that a company plans to restate its financial reports because of an error. Many times, those press reports are based on a press release and the Form 8-K.

✓

Changes in control of company:
Any departures of directors or principal officers, election of new directors, or appointment of new principal officers.

✓

Changes in charter or bylaws:
Any proposed change in the charter or bylaws and its impact on the company’s operations.

✓

Changes in fiscal year:
Any plans to change a company’s fiscal year if the decision is made outside the vote of the shareholders or by amend-ment to its bylaws. The company must include the date of determination, the date of the new fiscal year, and the form on which the report covering the transition period will be filed.

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✓

Temporary suspension of trading in company’s employee benefit
plans:
Any suspensions of employee benefit plans for a period of time.

Most often, such suspensions happen when the company changes from one benefit provider to another. However, this change can be a sign of a major decision impacting the company’s stock, such as a pending announcement about company earnings, a stock split, a buyback of stock, or an issuance of new stock.

✓

Amendments to the company’s code of ethics:
Any significant changes to the company’s code of ethics.

As you can see from this list, you’d never hear about most of these events if companies weren’t required to report them. But this information could be critical to any decision you make about the stock you currently hold or may want to buy.

Digging into Board Operations

Since the passage of the Sarbanes-Oxley Act of 2002 (see Chapter 3), the SEC

more closely scrutinizes a company’s board operations and the interaction between its board and shareholders. SEC staff continue to study the act’s requirements and to issue new disclosure requirements as they identify problems. Two major changes adopted since initial passage involve:

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Disclosure to investors about the board’s nominating committee and the nominating process for new board members

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Disclosure about the means by which the holders of a company’s securities can communicate with the board of directors

In most cases, this information appears on the company’s Web site or with its annual reports.

Note that I refer to “security holders” in some cases and “shareholders” in other cases. Not all security holders are shareholders. Only shareholders have voting rights within the company. Bonds are a type of security, so although bondholders don’t have voting rights like shareholders, they do have an interest in who serves on the board.

The nominating process

The newly adopted rules imposed by Sarbanes-Oxley regarding a public company’s nomination process demand that the board specify the following in writing to its shareholders:

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✓

Whether the nominating committee has a written charter and, if it
does, whether it’s available on the company’s Web site.
If the charter isn’t available on the Web site, the company must print it as part of its proxy information once every three years.

✓

Whether the members of the nominating committee are independent
(not directly involved in company operations).

✓

Whether the nominating committee accepts nominations from security
holders.
If the company allows nominations, it must include information about how security holders can nominate someone to be on the board. If the company doesn’t have a policy to accept nominations from security holders, it must explain why the board has decided not to accept these nominations.

✓

Minimum qualifications that the nominating committee believes must
be met by a person who’s recommended for a position on the company’s board of directors.
In addition, the company must list any specific qualities or skills that the nominating committee believes are needed for one or more of the open director’s positions.

✓

How the company evaluates director nominees, including those recommended by security holders.
If evaluation is different for committee nominees than it is for security holder nominees, the differences must be specified in the documentation as well.

After the nominations are set, the company needs to disclose to its shareholders whether the nominee was recommended by a security holder, a nonmanagement director, the chief executive officer, a third-party search firm, or by some other means. The board doesn’t have to disclose this information about nominees who are executive officers or directors standing for reelection.

The SEC reviews all
proxies
(paper ballots sent to shareholders) to see how the company presents the information concerning its nominating process.

If the SEC determines that the company doesn’t provide sufficient details, it can ask that the company expand its information.

Contacting board members

A company must put a process in place that permits security holders to send communications to the board of directors or supply a statement from the board explaining why it believes that not doing so is appropriate.

The board must make a public disclosure about its security-holder communications process that includes a description of how security holders can communicate with the board and, if applicable, a list of specific board members who deal with specific topics. If the board decides that not all security-holder 258
Part V: The Many Ways Companies Answer to Others

communications are to be sent directly to board members, it must specify how it selects which communications it sends to board members. This disclosure can be made on the company’s Web site or in annual reports.

Finding Out about Insider Ownership

As an investor, tracking the ownership of stock by insiders can give you a good idea of how they feel about owning the company’s stock. If most of the insiders buy the stock, that’s usually a good sign — the insiders believe in the long-term performance of the company. But if you find that insiders primarily sell their holdings, trouble could be brewing.

Forms 3, 4, and 5 are used to file information about holdings by individuals or entities who are directors, officers, or major shareholders (holders of more than 10 percent of the stock). Keep your eye on these three important forms to find out what insiders think of the stock:

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Form 3:
Filed when an individual or entity first takes ownership of stock

✓

Form 4:
Filed when an individual or entity changes ownership of stock

✓

Form 5:
Filed as an annual statement summarizing changes in stock ownership of directors, officers, or major shareholders

You can find forms filed with the SEC at www.sec.gov/edgar.shtml, but it’s easier to use certain financial Web sites to track stock transactions made by company insiders. On Yahoo! Finance (http://finance.yahoo.com/), after you get to the main page for a particular company, you find a link in the left column for insider transactions. You can also get a list of major stockholders by using the link in the right column for major holdings.

Chapter 20

Creating a Global Financial

Reporting Standard

In This Chapter

▶ Developing uniform global financial-reporting standards

▶ Seeing who benefits from standardization

▶ Examining the differences between reporting systems

As more and more companies operate globally, the need grows for common financial reporting rules. Today, many global companies must prepare financial statements in every country in which they operate to meet each country’s reporting requirements. They also must keep the books according to U.S. generally accepted accounting principles (GAAP) rules (see Chapter 18), if the company is a U.S. company, and must meet the standards of the International Financial Reporting Standards (IFRS), or possibly other standards set by government officials in the country in which they’re based.

Financial regulatory institutions plan to meld the standards at some point in the future. Today, over 100 countries use IFRS as the public reporting standard. By 2011, the IFRS may be used in almost every country, including the U.S. In this chapter, I explore why a move to develop a global public reporting standard is underway, and I introduce you to the key players who are creating this standard. I also discuss the primary benefits of a worldwide standard and talk about some key differences between the U.S. GAAP and the IFRS.

Why Develop a Worldwide

Financial Standard?

Have you ever tried to compare a U.S. company to a company in another country and been frustrated with how difficult it is to be looking at apples to oranges? Financial reporting rules differ from country to country, so you can 260
Part V: The Many Ways Companies Answer to Others

never be certain you’re comparing the same information about assets, liabilities, equity, revenue, or expenses. These differences in reporting can make trying to decide which company’s stock to buy very difficult.

Companies that operate in more than one country have bigger problems than those that operate in only one country because they must report results to each country in which they operate, as well as to the country in which they’re based. This can result in numerous different accounting systems that must constantly be translated to match the rules for each set of financial reports.

For example, a global U.S. company operating in Canada must report results in Canada according to the Canadian GAAP. If the firm is listed on the London exchange, it must also prepare statements to meet the IFRS, and it would need to prepare another set of statements under the rules of the U.S. GAAP.

Imagine doing that for every country in which the business operates. U.S.

companies that operate in 100 countries or more face a nightmare trying to get the financial statements to meet all these varying requirements. Anything that can simplify this process benefits both the companies that must prepare the statements and the investors trying to interpret the differences.

Key Moves to Reshape Global

Financial Reporting

So how did the process get started to reshape the global financial road map, and who are the key players?

In 2002, the U.S. Financial Accounting Standards Board (or FASB, which issues GAAP rules) and the London-based International Accounting Standards Board (or IASB, which issues the IFRS) entered into the Norwalk Agreement, which lays out a plan to undertake efforts to converge the U.S.

GAAP and the IFRS. The primary difference between the two is that the IFRS

are more focused on objectives and principles and less reliant on detailed rules than the GAAP.

After much discussion and negotiation, the European Commission began its project on the equivalence of national GAAP and the IFRS and issued a draft report in 2005. The U.S. Securities and Exchange Commission (SEC) followed with its development of the “IFRS Road Map” in 2005.

In 2006, the FASB and IASB reaffirmed their commitment to converge the two reporting systems and updated the Norwalk Agreement based on findings in the 2005 reports. In 2007, the SEC eliminated the requirement for foreign companies that use IFRS to reconcile to the GAAP. The first major step in accepting IFRS in financial reports circulated to U.S. investors.

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In 2007, in another major step to accept IFRS reporting requirements by U.S. companies, the SEC issued a “concept release” on the topic of allowing U.S. companies a choice between filing their reports based on IFRS or GAAP

requirements. A concept release opens up the question and seeks comments. The SEC has not yet permitted U.S. companies to use IFRS reporting requirements for SEC reports, but it did move a step closer in May 2008 when it released a “proposing release” on the matter. The proposing release proposes the change and asks for comments.

SEC Chairman Christopher Cox is leading the effort to permit the use of IFRS and spoke favorably about this option in a speech to the International Organization of Securities Commissions in Paris in May 2008. If the organization adopts the proposing release, U.S. companies will be able to use IFRS for SEC reporting purposes by 2011.

The U.S. will be one of the last countries to jump on this bandwagon. Israel adopted IFRS in 2008. Chile and Korea plan to adopt IFRS in 2009. Brazil is set to adopt IFRS in 2010 and Canada in 2011. So if the U.S. does jump on the bandwagon in 2011, global corporations will be able to adopt IFRS for almost all their reporting.

Who Benefits from a Global

Standard and How?

Companies that must prepare the reports, and investors, government agencies, and vendors that must use the reports, will all benefit from a global standard. It’s very hard to make an informed decision when companies use varying regulations for reporting their finances.

Investors

Every day, investors seek ways to get high-quality financial information that accurately reflects a company’s true financial results. Any investor burned by the mortgage mess in 2007, when key financial institutions kept major holdings off the books, knows how critical accurate financial reporting can be to their decision making.