In this article we will discuss about the financial reporting of securities and exchange commission.

The Work of the Securities and Exchange Commission:

In the United States, the responsibility for ensuring that complete and reliable information is available to investors lies with the Securities and Exchange Commission (SEC), an indepen­dent agency of the federal government created by the Securities Exchange Act of 1934. Although the SEC’s authority applies mainly to publicly held companies, the commission’s guidelines and requirements surely have been a major influence in the United States on the development of all generally accepted accounting principles.

The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

As more and more first-time investors turn to the markets to help secure their futures, pay for homes, and send children to college, our investor protection mission is more compelling than ever.


As our nation’s securities exchanges mature into global for-profit competitors, there is even greater need for sound market regulation.

And the common interest of all Americans in a growing economy that produces jobs, improves our standard of living, and protects the value of our savings means that all of the SEC’s actions must be taken with an eye toward promoting the capital formation that is necessary to sustain economic growth.

The world of investing is fascinating and complex, and it can be very fruitful. But unlike the banking world, where deposits are guaranteed by the federal government, stocks, bonds and other securities can lose value, there are no guarantees. That’s why investing is not a spectator sport. By far the best way for investors to protect the money they put into the securities markets is to do research and ask questions.

The laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it. To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public.


This provides a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular security. Only through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions.

The SEC is headed by five commissioners appointed by the president of the United States (with the consent of the Senate) to serve five-year staggered terms. To ensure the bipartisan nature of this group, no more than three of these individuals can belong to the same political party. The chairman is from the same political party as the president. The commissioners pro­vide leadership for an agency that has grown over the years into an organization with approx­imately 3,100 employees in 11 regional and district locations.

Despite its importance, the SEC is a relatively small component of the federal government. However, the SEC generates sig­nificant fees primarily from issuers, relative to 8-K, 10-K, 10-Q, and registration statement fees. In 2003, the SEC deposited $1,076 billion in the United States Treasury. Furthermore, in fiscal year 2006, the SEC collected $1.8 billion in disgorgements and penalties.

The SEC is composed of four divisions and 18 offices including the following:


i. The Division of Corporation Finance has responsibility to ensure that publicly held com­panies meet disclosure requirements. This division reviews registration statements, annual and quarterly filings, proxy materials, annual reports, and tender offers.

ii. The Division of Market Regulation oversees the securities markets in this country and is responsible for registering and regulating brokerage firms. This division also oversees the Securities Investor Protection Corporation (SIPC), a nonprofit corporation that provides insurance for cash and securities held by customers in member brokerage firms. This insur­ance protects (“insures”) against the failure of the member brokerage firms.

iii. The Division of Enforcement helps to ensure compliance with federal securities laws. This division investigates possible violations of securities laws and recommends appropriate remedies. The most common issues facing this division are insider trading, misrepresenta­tion or omission of important information about securities, manipulation of the market price of a security, and issuance of securities without proper registration. According to the SEC’s annual report, 914 investigations of possible violations were opened during 2006.

iv. The Division of Investment Management oversees the $15 trillion investment management industry and administers the securities laws affecting investment companies including mutual funds and investment advisers. This division also interprets laws and regulations for the public and the SEC staff.


v. The Office of Information Technology supports the SEC and its staff in all aspects of infor­mation technology. This office operates the Electronic Data Gathering Analysis and Retrieval (EDGAR) system, which electronically receives, processes, and disseminates more than half a million financial statements every year. This office also maintains a very active Web site that contains a tremendous amount of data about the SEC and the securities industry and free access to EDGAR.

vi. The Office of Compliance Inspections and Examinations determines whether brokers, deal­ers, and investment companies and advisers comply with federal securities laws.

vii. The Office of the Chief Accountant is the principal adviser to the commission on account­ing and auditing matters that arise in connection with the securities laws. The office also works closely with private sector bodies such as the FASB and the AICPA that set various accounting and auditing standards.

Purpose of the Federal Securities Laws:

Before examining the SEC and its various functions in more detail, a historical perspective should be established. The development of laws regulating companies involved in interstate commerce was discussed as early as 1885. In fact, the Industrial Commission created by Congress suggested in 1902 that all publicly held companies should be required to disclose material information including annual financial reports.


However, the crisis following the stock market crash of 1929 and the widespread fraud that was subsequently discovered were necessary to prompt Congress to act in hope of reestablishing the trust and stability needed for the capital markets.

Before the Great Crash of 1929, there was little support for federal regulation of the securities markets. This was particularly true during the post-World War I surge of securities activity. Proposals that the federal government require financial disclosure and prevent the fraudulent sale of stock were never seriously pursued. Tempted by promises of “rags to riches” transformations and easy credit, most investors gave little thought to the dangers inherent in uncontrolled market opera­tion.

During the 1920s, approximately 20 million large and small shareholders took advantage of post-war prosperity and set out to make their fortunes in the stock market. It is estimated that of the $50 billion in new securities offered during this period, half became worthless.

When the stock market crashed in October 1929, the fortunes of countless investors were lost. With the Crash and ensuing depression, public confidence in the markets plummeted. There was a consensus that for the economy to recover, the public’s faith in the capital markets needed to be restored.


As a result, Congress enacted two primary pieces of securities legislation designed to restore investor trust in the capital markets by providing more structure and government oversight:

i. The Securities Act of 1933, often referred to as the truth in securities law, regulates the ini­tial offering of securities by a company or underwriter.

ii. The Securities Exchange Act of 1934, which actually created the SEC, regulates the subse­quent trading of securities through brokers and exchanges.

These laws put an end to the legality of many abuses that had been common practices such as the manipulation of stock market prices and the misuse of corporate information by officials and directors (often referred to as inside parties) for their own personal gain. Just as impor­tant, these two legislative actions were designed to help rebuild public confidence in the cap­ital market system. Because of the large losses suffered during the 1929 market crash and subsequent depression, many investors had begun to avoid buying stocks and bonds.


This reduction in the pool of available capital dramatically compounded the economic problems of the day.

The creation of federal securities laws did not end with the 1933 Act and the 1934 Act. During the decades since the first commissioners were appointed, the SEC has administered rules and regulations created by a number of different congressional actions. Despite the pas­sage of subsequent legislation, this organization’s major objectives have remained relatively constant.

Over the years, the SEC has attempted to achieve several interconnected goals including these:

i. Ensuring that full and fair information is disclosed to all investors before the securities of a company are allowed to be bought and sold.

ii. Prohibiting the dissemination of materially misstated information.

iii. Preventing the misuse of information especially by inside parties.


iv. Regulating the operation of securities markets such as the New York Stock Exchange, American Stock Exchange, and the various over-the-counter exchanges.

In many ways, the SEC’s work has been a huge success. The value of the securities that have been registered as well as the volume of these securities bought and sold each business day are staggering by any standard. Over the decades, the number of individuals and institutions (from both inside and outside the United States) willing to take the risk of making financial invest­ments has grown to incredible numbers. In 2006 alone, more than 1 trillion shares were exchanged.

However, a cloud recently has rested over the entire U.S. capital market system. During 2001 and 2002, a number of highly publicized corporate scandals shook public confi­dence in the financial information available for decision-making purposes.

Where once most investors appeared to believe in the overall integrity of the stock markets, that faith has clearly been diminished although the problem has not reached the magnitude seen in the 1930s. This lack of confidence has been a drag on the general willingness to invest and, thus, on the econ­omy as a whole.

Almost an unlimited number of reasons can be put forth for these scandals:

i. Greed by corporate executives.

ii. Failure in the corporate governance process as practiced by many boards of directors.

iii. Failure of public accounting firms to apply appropriate quality control measures to ensure independent judgments.

iv. Shortcomings in promulgated standards used to self-regulate the accounting profession.

v. Unreasonable market expectations brought on by years of skyrocketing stock values fueled in part by technology stocks.

vi. A workload that overburdened the Securities and Exchange Commission, which the rela­tively small agency could not handle in an adequate fashion.

As a result, on July 30, 2002, President George W. Bush signed the Sarbanes-Oxley Act of 2002. This wide-ranging legislation was designed to end many of the problems that have plagued corporate reporting and the securities markets in recent years in the hope of restoring public confidence.

This new law has had an enormous impact on public accounting as well as the reporting required in connection with the issuance of secu­rities. However, as with most new legislation, it will take a considerable period of time for the overall implementation of the Sarbanes-Oxley Act.

Full and Fair Disclosure:

No responsibility of the SEC is more vital than of ensuring that a company disclosed suffi­cient, reliable information before its stocks, bonds, or other securities can be publicly traded. Recent problems with companies such as Enron, WorldCom, Global Crossing, and Tyco have drawn increased attention to this role.

Unless specifically exempted, all publicly held companies (frequently referred to as registrants) must periodically file with the SEC detailed reports.

The SEC requires and regu­lates these filings as a result of a number of laws passed by Congress over the years:

1. Securities Act of 1933:

Requires the registration of new securities offered for public sale so that potential investors can have adequate information. The act is also intended to prevent deceit and misrepresentation in connection with the sale of securities.

2. Securities Exchange Act of 1934:

Created the SEC and empowered it to require reporting by publicly owned companies and registration of securities, security exchanges, and certain brokers and dealers. This act prohibits fraudulent and unfair behavior such as sales practice abuses and insider trading.

3. Public Utility Holding Company Act of 1935:

Requires registration of interstate holding companies of public utilities covered by this law. This act was passed because of abuses in the 1920s in which huge, complex utility empires were created to minimize the need for equity financing.

4. Trust Indenture Act of 1939:

Requires registration of trust indenture documents and sup­porting data in connection with the public sale of bonds, debentures, notes, and other debt securities.

5. Investment Company Act of 1940:

Requires registration of investment companies, includ­ing mutual funds that engage in investing and trading in securities. This act is designed in part to minimize conflicts of interest that arise with fund management.

6. Investment Advisers Act of 1940 and Securities Investor Protection Act of 1970:

Require investment advisers to register and to follow certain standards created to protect investors.

7. Foreign Corrupt Practices Act of 1977:

Affects registration indirectly through amendment to the Securities Exchange Act of 1934. This act requires the maintenance of accounting records and adequate internal accounting controls.

8. Insider Trading Sanctions Act of 1984 and Insider Trading and Securities Fraud Enforcement Act of 1988:

Also affect registration indirectly. Increase the penalties against persons who profit from illegal use of inside information and who are associated with market manipulation and securities fraud.

9. Sarbanes-Oxley Act of 2002:

As discussed in a later section of this chapter, designed as an answer to the numerous corporate accounting scandals that came to light in 2001 and 2002. This act mandated a number of reforms to bolster corporate responsibility, strengthen dis­closure, and combat fraud. It also created the Public Company Accounting Oversight Board (PCAOB) to oversee the accounting profession.

SEC Requirements:

As is obvious from the previous list of statutes, the SEC administers extensive filing requirements. Thus, accountants who specialize in working with the federal securities laws must develop a broad knowledge of a great many reporting rules and regulations. The SEC specifies most of these disclosure requirements in two basic documents, Regulation S-K and Regulation S-X, which are supplemented by periodic releases and staff bulletins.

Regulation S-K established requirements for all nonfinancial information contained in fil­ings with the SEC. Descriptions of the registrant’s business and its securities are just two items covered by these regulations. A partial list of other nonfinancial data to be disclosed includes specified data about the company’s directors and management, management’s discussion and analysis of the current financial condition and the results of operations, and descriptions of both legal proceedings and the company’s properties.

Regulation S-X prescribed the form and content of the financial statements (and as the accompanying notes and related schedules) included in the various reports filed with the SEC. Thus, before being accepted, all financial information must meet a number of clearly specified requirements.

The SEC’s Impact on Financial Reporting to Stockholders:

The SEC’s disclosure and accounting requirements are not limited to the filings made directly with that body. Rule 14c-3 of the 1934 act states that the annual reports of publicly held com­panies should include financial statements that have been audited. This information (referred to as proxy information because it accompanies the management’s request to cast votes for the stockholders at the annual meeting) must present balance sheets as of the end of the two most recent fiscal years along with income statements and cash flow statements for the three most recent years. Rule 14c-3 also states that additional information, as specified in Regulation S-K, should be included in this annual report.

Over the years, the SEC has moved toward an integrated disclosure system. Under this approach, much of the same reported information that the SEC requires must also go to the shareholders. Thus, the overall reporting process is simplified because only a single set of information must be generated in most cases. The integrated disclosure system is also intended as a way to improve the quality of the disclosures received directly by the shareholders.

Information required in proxy statements, which the shareholders receive directly, includes the following:

1. Five-year summary of operations including sales, total assets, income from continuing operations, and cash dividends per share.

2. Description of the business activities including principal products and sources and avail­ability of raw materials.

3. Three-year summary of industry segments, export sales, and foreign and domestic operations.

4. List of company directors and executive officers.

5. Market price of the company’s common stock for each quarterly period within the two most recent fiscal years.

6. Any restrictions on the company’s ability to continue paying dividends.

7. Management’s discussion and analysis of financial condition, changes in financial condi­tion, and results of operations. This discussion should include liquidity, trends and signifi­cant events, causes of material changes in the financial statements, and the impact of inflation on the company.

In addition, even prior to passage of the Sarbanes-Oxley Act, the SEC required certain dis­closures in proxy statements describing the services provided by the registrant’s independent external auditor. This information was intended to help ensure that true independence was not endangered. Apparently, mere disclosure was not adequate in all cases.

Such disclosure must include the following:

1. All non-audit services provided by the independent auditing firm.

2. A statement as to whether the board of directors (or its audit committee) approved all non-audit services after considering the possibility that such services might impair the external auditor’s independence.

3. The percentage of non-audit fees to the total annual audit fee. This disclosure helps indicate the importance of the audit work to the firm versus the reward from any other services pro­vided to the registrant.

4. Individual non-audit fees that are more than 3 percent of the annual audit fee.