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Accounting and auditing procedures required by the Securities and Exchange Commission in the preparation of financial statements

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ACCOUNTING AND AUDITING PROCEDURES REQUIRED BT
THE SECURITIES AND EXCHANGE COMMISSION
IN THE PREPARATION- OF FINANCIAL STATEMENTS
A Thesis
Presented to
the Faculty of the Department of Accounting
The University of Southern California
In Partial Fulfillment
of the Requirements for the Degree
Master of Business Administration
■by
Conrad Mattson, Jr.
June 1941
UMI Number: EP43154
All rights reserved
INFORMATION TO ALL USERS
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In the unlikely event that the author did not send a complete manuscript
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a note will indicate the deletion.
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UMI EP43154
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unauthorized copying under Title 17, United States Code
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T h i s thesis, w r i t t e n by
....
u n d e r the d i r e c t i o n o f h . l s . F a c u l t y C o m m it te e ,
a n d a p p r o v e d by a l l its m e m b e r s , has been
presented to a n d accepted by the C o u n c i l on
G r a d u a t e S t u d y a n d Research in p a r t i a l f u l f i l l ­
m ent o f the re q u ire m e n ts f o r the degree o f
.i^STER..OF.. BUSINESS.. ADMIIIIST.M.TIQM...
Secretary
F a c u lty Com m ittee
TABLE OF CONTENTS
CHAPTER
I
II
III
PAGE
BACKGROUND STND PURPOSE OF THE SECURITIES EXCHANGE
A C T ...............................................
1
REGISTRATION STATEMENT REQUIREMENTS . . . . . . . .
5
EXAMINATION OF REGISTRATION STATEMENTS AND
ISSUANCE OF "STOP ORDER1' El THE COMMISSION . . .
IV
V
REGISTRATION STATEMENT FORMS
.....................
11
17
FINANCIAL STATEMENTS - PREPARATION AND AUDITING
P R O C E D U R E ........................................
28
Call l o a n s ...................
35
Notes and accounts r e c e i v a b l e ...................
35
Reserve for bad d e b t s ............................
35
I n v e n t o r i e s ....................................... '
35
Marketable s e c u r i t i e s ..............
37
Indebtedness of officers, directors, stockholders,
and others, c u r r e n t ......... ’..................
37
Indebtedness of subsidiary and/or affiliated
............................
38
Unamortized debt discount and e x p e n s e ...........
38
Stock discount and e x p e n s e s .....................
39
Prepaid expenses
39
companies, current
................................
Other deferred charges
Subscribers to capital stock
.................
...
.............
40
40
iii
CHAPTER
PAGE
Securities and subsidiary and/or affiliated
c o m p a n i e s ................... * .................. 41
Other investment s e c u r i t i e s ................. -. . 42 .
Indebtedness of subsidiary and/or affiliated
companies, not c u r r e n t ........................... 44
Other i n v e s t m e n t s ................................. 45
Property, plant and equipment
........
. . . . .
45
Reserves for depreciation and depletion
........
50
. . . .
52
Intangibles
. . . . .
...................
L i a b i l i t i e s ...................
55
Contingent l i a b i l i t i e s ..............
57
R e s e r v e s ........................
62
Capital s t o c k .......................
63
Surplus
................................... 64
Profit and loss and earnedsurplus accounting
. . 67
Profit and. loss s t a t e m e n t .......................68
VI
LIABILITIES AND RESPONSIBILITIES OF ACCOUNTANTS
UNDER THE A C T ......................................72
BIBLIOGRAPHY
. . ..........
8l
CHAPTER I
BACKGROUND AND PURPOSE OF THE SECURITIES EXCHANGE ACT1
The Securities Act of 1933 became law on May 27, 1933It was amended by the Securities Exchange Act June 6, 193^*
The events leading up to the passage of Federal legislation
relating to the sale of investment securities to supplement
and strengthen State laws need but little explanation.
Dis­
closures in financial circles subsequent to the stock market
crash of 1929 shook public confidence to its very foundation.
A considerable number of issues were found to have grossly
misrepresented values and concealed essential facts -- often
in fraudulent or criminal transactions.
State laws failed to curb the distribution of unsound
securities which deluged the markets.
This was attributable
to a number of factors which may be summarized as follows:2
a.
Absence of protective legislation in certain
States and inadequate legislation in
b.
others.
Lack of uniformity in the
laws of the various
Willingness of victims to
condone the offense or
States.
c.
1 Hereinafter referred to as the Act.
2 Hearing on Securities Act before Committee on InterState and Foreign Commerce, House of Representatives, 73rd
Congress, 1st session, p. 99.
accept a compromise.
d.
Evasions possible by conducting sales on an inter­
state basis.
The lack of adequate protective lavs and the existence
of too liberal corporation legislation in some jurisdictions
not only furnished fertile fields for promoters and dealers,
but, vhat is more important, offered the fraudulent promoter
a legal haven from which to direct his operations in other
States.
The seriousness of this factor had been emphasized
in numerous proceedings before the Courts.
The varying requirements of the statutes of different
States also_ interfered with the full effectiveness of State
legislation.
Each State naturally desired to attract capital
and to persuade industries to locate within its borders.
One of the greatest obstacles in the way of more effec­
tive enforcement of protective securities laws was the willing­
ness of victims to forego prosecution upon the promoter or
dealer agreeing to refund part of the purchase price.
It often
happened, that, after a prosecuting attorney had prepared a
satisfactory case against a fraudulent promoter or dealer, the
prosecuting witness accepted a refund and the case failed for
lack of sufficient evidence.
Many States had endeavored to correct this evil by in­
cluding various regulations in their statutes, but it was well
recognized that they were powerless in the matter of interstate
transactions and that a supplemental Federal law was needed
to stop this gap through which were being wasted so many millions
of dollars of public savings that might otherwise have been
diverted to substantial industrial development.
Those who had given the subject more than casual-con­
sideration had long recognized the need for Federal legisla­
tion relating to the sale of investment securities.
Immediately
after the termination of the World War, and inspired by a deluge
of fraudulent promoters and their success in exchanging the worth­
less securities of resourceless projects for Liberty Bonds and
the public's savings, a number of bills were introduced in
Congress, particularly between 1918 and 1921.
None of them
was ever reported out of the Congressional Committees.
The introduction tovthe Act reads as follows:
An act to provide full and fair disclosure of the
character of securities sold in interstate and for­
eign commerce and through the mails, and to prevent
frauds in the sale thereof, and for other purposes.
The period between the enactment of the law in 1933
and the amendments in 193^ developed considerable contention
that indispensable financing could not proceed and that it was
necessary to correct outstanding defects in the law in order
to permit the ordinary conduct of flotations, without in any
way eliminating the requirement that full and adequate infor­
mation concerning securities should be supplied to investors.
Particularly emphatic was the expressed unwillingness of
directors, officers, bankers, and accountants to accept the
liabilities imposed.
The amendments to the law which were signed by Presi­
dent Roosevelt on June 6, 1934 effected material aid in
removing the bar raised by those who had criticized the Act
as a serious hindrance to the flow of capital ordinarily
assured by the distribution of securities.
They did, however,
little to ease the difficult task of compiling registration
statements under all conditions where there is a public offer­
ing.
Nor did they altogether remove the extreme penalties
provided in the 1933 -Act in order to compel proper disclosures
to investors, by issuers, officers, directors, underwriters,
experts, and others.
The administration of the Act was charged to the Federal
Trade Commission in the period from May 27, 1933 to September
1, 1934, at which date the administration of the Act was turned
over to the Securities and Exchange Commission.^
5 Hereinafter referred to as the Commission.
CHAPTER II
REGISTRATION STATEMENT REQUIREMENTS
The registration statement frequently referred to in
the Act Is a document filed with the Commission setting out
at length the information required to he furnished in connec­
tion with the Issuance of all securities, except those exempt
by virtue of the provisions of the Act.
Unless a registration statement is on file and is in
full effect, it is unlawful for any person through any agency
of interstate commerce or the mails, directly or Indirectly,
to sell, offer for sale, offer to buy any security, or transport
the same for delivery after sale.
The registration Is not in
effect until the twentieth day after the statement is filed
during which the prescribed information is open to both public
inspection and.Intensive review by the Commission to ascertain
whether (a) sale of the security shall be permitted, (b) sale
shall be delayed pending the filing of additional data, (c)
the registration statement may be voluntarily withdrawn by the
issuer, or (d) the security denied registration by the Co m ­
mission.
Even after a registration statement has been in
effect, the sale of the security may be suspended by the Com­
mission if it shall find that the law has been violated In
any material respect.
The necessity for filing of the registration statement
does not apply to this group of exempted securities:
issued prior to July 27, 1933;
those
those issued hy governments
or political subdivisions, railroads, banks, eleemosynary
institutions, building and loan associations, trustees or r e ­
ceivers in bankruptcy^ insurance policies; commercial paper;
any issues up to $30,000 (subject to certain requirements),
issues limited to $100,000 and sold for each; stock in trust
and unincorporated associations; notes or bonds secured by
first mortgages or deeds of trust on real estate; exchanges
of securities under $100,000; certificates of deposit covering
securities not in excess of $100,000; voting-trust certificates
aggregating $100,000 or less; or fractional gas or oil interests
not in excess of $100,000.
The following transactions are likewise exempt from
registration:
ordinary trading transactions by a person other
than an issuer, underwriter, or dealer; private offerings by
an issuer; transactions by a dealer at least one year after
the public offering of the securities in question; unsolicited
brokers'
transactions; exchange of securities exclusively with
existing security holders where no commission is paid for their
solicitation; exchanges with existing security holders, or
creditors in connection with a reorganization under court
supervision; and, sales by an issuer resident within a State
only to persons resident within the same State.
7
Section 6(a) of the Act gives the following provisions
describing the registration statement:
Any security may be registered with the Commission
under the terms and conditions hereinafter provided, by
filing a registration statement in triplicate, at least
one of- which shall be signed by each issuer, its prin­
cipal executive officer or officers, its principal
financial officer, its comptroller or principal
accounting officer, and the majority of its board of
directors or persons performing similar functions (or,
if there is no board of directors or persons performing
similar functions, by the majority of the persons or
board having the power of management of the issuer),
and in case the issuer is a foreign or territorial
person by its duly authorized representative in the
United States; except that when such registration
statement relates to a security issued by a foreign
government, or political subdivision thereof, it need
be signed only by the underwriter of such security.
Signatures of all such persons when written on the
said registration statements shall be presumed to have
been so written by authority of the person whose
signature is so affixed and the burden of proof, in
the event such authority shall be denied, shall be
upon the party denying the same. The affixing of any
signature without the authority of the purported
signer shall constitute a violation of the title.
A registration statement shall be deemed effective
only as to the securities specified therein as
proposed to be offered."
Section 6(b) definitely prescribes the fees to be
paid:
At the time of filing a registration statement,
the applicant shall pay to the Commission a fee of
one one-hundredth of one percentum of the maximum
aggregate price at which such securities are proposed
to be offered, but in no case shall such fee be less
than $25.
The fees are payable in cash, United States postal
money order, or certified bank checks made payable to the
order of the Commission.
Where securities are to be offered "at the market"
the fee payable is to be based upon the price for which units
of securities of the same class of the issuer were sold or
would have been sold on a specified date within fifteen days
prior to the filing of the registration statement.
The Commission's forms contain specific instructions
for the determination of the fees for registration of the
various types of securities.
Within ten days after the securities are actually
offered to the public, the registrant is required to file with
the Commission a statement of the actual price for which the
security was offered, with an explanation of any difference
between that and the price upon which the fee was based.
Any
intentional misstatement of the price at which the issue is
proposed to be offered with a view to paying a smaller fee
than the circumstances require may result in a stop order by
the Commission under its power derived from Section 8 of the
Act or in criminal prosecution under Section 24.
Three copies of the registration statement, only one
of which need contain the requisite signatures, must be fur­
nished the Commission.
Knowledge of the date of filing the registration state­
ment is essential for the calculation of the date on which the
statement becomes effective.
The date of filing is the date
on which the papers are actually received at the office of
9
the Commission at Washington D. C., provided that the proper
fee has been paid and all requirements have been complied with,
regarding the Act and the rules and regulations of the Commis­
sion with reference to filing.
Section 6(c) defines the filing
date as follows:
The filing with the Commission of a registration
statement, or of an amendment to a registration
statement, shall be deemed to have taken place upon
the receipt thereof, but the filing of a registration
statement shall not be deemed to have taken place
■unless it is accompanied by a United States postal
money order or a certified bank check or cash for
the amount of the fee required under subsection (b)
Where additional blocks of a security for which a
registration statement is already in effect are to be offered,
a separate registration statement for the new block must be
filed.
In this case, and in any other where an issuer has
previously filed, registration statements, the exhibits, or
parts thereof which are applicable to subsequent registrations
the issuer may make, need not be set forth at length there­
after but may be incorporated into future registration state­
ments by specific reference.
Any additional information
necessary to make such exhibits complete may be added.
However,
if such inforporation by reference will, in the opinion of
the Commission, cause confusion, It may be denied and the
issuer required to repeat the exhibit or document in full.
Registrants are required in their registration state­
ments to designate a person to receive notices and communications,
and. to confer upon him the power (a) to amend the statement
by changing the date of the proposed offering, (b) to with­
draw the registration statements or amendments made thereto,
and (c) to consent to the entry of an order issued under
Section 8(b), waiving notice and hearing.
Such order will
be understood to be without prejudice to the right of the
registrant thereafter to have it vacated upon a showing that
the registration statement as amended is no longer incomplete
or inaccurate on its face in any material respect.
Naming a person who is authorized to receive communica­
tions relative to the statement is considered a conferring of
the foregoing powers on such person, unless there is an
express denial to that effect in which event a separate a u ­
thorization of an agency for those purposes must be made.
CHAPTER III
EXAMINATION OF REGISTRATION STATEMENTS
AND ISSUANCE OF "STOP ORDER" BY THE
COMMISSION
Registration statements which are filed are examined
by the Commission.
If a statement is found on its face to be
incomplete or inaccurate in a material respect, the Commission
is empowered to issue an order preventing the statement from
going into effect until it is amended to correct the defect.
This order must be preceded by a verified notice at least ten
days prior to the date it would ordinarily become effective
and an opportunity must be given the registrant to be heard.
If at any time, whether.before or after the effective
date, it appears to the Commission that the registration state­
ment contains an untrue statement of a material fact, or if
it fails to state any required material fact, or any fact
required to make any statement therein not misleading, the
Commission may notify the issuer and afford it a hearing on
the matter within fifteen days after the notice.
After the
hearing, if it is still cnnvinced of the untruth or omission,
the Commission may issue a stop order suspending the effec­
tiveness of the statement.
The Commission's jurisdiction to issue a stop order
under Section 8(a) is conditioned upon the existence of untrue
statements with regard to, or omissions to state, material
facts.
But it has determined that, given such material
deficiencies, the stop order may embrace in its terms other
deficiencies which have been included in the notice to show
cause and established as deficiencies.
It may be noted that a stop order must be based on a
misstatement or omission of a "fact" and not an opinion.
But a prophecy known to be untrue as of the time it is made is
to be regarded as an untrue statement of fact inasmuch as It
misstates the mind of the person making the prophecy.1
In determining whether a material misstatement or
omission has been made, the Commission has complete authority
to make an examination of books and records, to examine w i t ­
nesses under oath, and to require certification of the issuer*
figures by accountants.
Failure of the issuer or -underwriter
to cooperate in this investigation or active obstruction on
their part are grounds for the issuance of a stop order.
Accountants will be interested to note various infrac­
tions which have thus far provoked the issuance of stop orders
by the Commission.
Among others are the
following:^
Balance sheets and profit and loss statements not
certified to by an independent public or certified accountant.
Failure to furnish particular exhibits.
Failure to state the remuneration paid to each director
1 Federal Trade Commission v. Howard.
March 21, 1934.
Opinion dated
2 Securities and Exchange Commission Release No. 1340,
pp. 81 -85 .
13
Failure to file a prospectus.
Presence of inconsistent dates (the date set for the pro­
posed offering being earlier than that possible because of the
waiting period).
Failure to record that the registrant was prohibited from
selling its stock in a particular State.
Failure to reconcile and tie in the prospectus with the
data in the registration statement.
Unauthorized use of a person's name as a director.
Failure to reply to query as to material contracts that
a commitment for a loan to carry out a reorganization had been
obtained.
Failure to set out contract to remunerate depository for
services.
Failure to list as an underwriter a person who had an o p ­
tion to purchase an entire issue of 200,000 shares.
Statement that stock was to be given away, when in fact
it was subject to assessment (which constituted a sale).
Registration effected for only 600,000 shares when in
fact subscriptions for 1,600,000’ shares were accepted.
Failure to state sinking-fund provisions in connection
with an issue of bonds secured by a mortgage, and omission
to state that the funded debt constituted a prior lien on
the property subject to the mortgage.
14
Answering "none" to question in registration statement
as to nature and extent of the interest of every new director
and principal officer in any property acquired or proposed to
be acquired.
The answer was held to ‘be too indefinite as not
indicating whether it referred to the officials or their
interests.
Answering "none" to question as to business connections
between issuer and depositaries, when in fact depository had
previously acted as such for one of the controlling companies.
Answering that there was no underwriter (in the case
of a call for deposits) when the fact was that the registrant
had received substantial profits in the original distribution
of the securities now called for deposit and had received
fuether substantial profits in acting as a reorganization
committee for the bonds it had originally distributed.
Failure to state that others were seeking deposit of the
same securities in answer to question to that effect.
Failure to state the relationship between the members
of the issuer and the depositary.
Statement in a prospectus that the cash to be returned
to the depositors would exceed that to non-d.epositors.
While
this was in the nature of an opinion or prophecy, rather than
the statement of a present untrue fact, since the president
of the company held little hope that there would be any cash
to distribute to anybody, it was deemed to be an untrue
15
statement of fact.
Failure to state that the registrant was obligated to
pay certain fees in connection with the call for deposits.
Failure to state that suit for appointment of a receiver
was pending in response to a question if there were pending
or threatened legal proceedings which might materially affect
the securities called for deposit.
Even if this were not
known at the time the statement was filed, it should have been
amended, before the effective date, to include it.
When the Commission is satisfied that there have been
errors or omissions in the statement, the registrant has the
option of filing amendments to rectify the errors or omissions
or it may refuse to do so.
In the event of such refusal, the
Commission is empowered to issue a stop order pursuant to
Section 8(b) and (d).
Section 9 of the Act provides for a
court review if a registrant believes that any such order is
unjustified.
If the registrant is unwilling to amend or does not wish
to have the order reviewed, he may request permission of the
Commission to withdraw the registration statement.
This consent
will be granted by the Commission only if it considers it proper
after giving due regard to the public interest and the protec­
tion of investors.
In the latter event, the papers remain in
the Commission’s files but are marked to indicate that they
have been withdrawn with the consent of the Commission.
The
16
fee -will not be returned.3
A registrant may waive the notice and hearing to which
he is entitled under Section 8(b) and (d) and may consent, to
the entry of an order requiring him to amend the statement.
The order will be vacated when the Commission is satisfied
that the registration statement as amended is no longer in­
complete or inaccurate on its face.
3 Federal Trade Commission Rule adopted September 22,1933*
CHAPTER IV
REGISTRATION STATEMENT FORMS
Special forms have been created by the Commission for
the use of the following:
A-l
Ordinary issuers without any history as to earnings
and. operations.
A -2
Ordinary issues of seasoned corporations with a
history of earnings, dividends and operations.
C-l
Unincorporated trusts (not having a board of direc­
tors or persons performing similar functions) of the fixed or
restrieted-management type having a depositor or sponsor.
D-l
Certificates of deposit to be used in anticipation
of or in connection with a plan of reorganization or adjustment.
E-l
Seuurities to be issued pursuant to a plan for r e ­
adjustment or reorganization.
F-l
Voting trust certificates.
G-l
Producing oil and gas royalty interests.
G-2
Non-producing oil and gas royalty interests.
As form A -2 is by far the most important and serves best
as an illustration of requirements of the Act, it will be
analyzed in detail in a subsequent chapter.
Requirements under
the other types of forms will be set forth briefly.
Form C-l.
The type of investment trust that is incor­
porated and has a board of directors, or persons performing
18
similar functions, and is not of the fixed or restrictedmanagement type with a depositor or sponsor, presents its data
on form A -2.
The unincorporated group is required to use
form C -1.
The information to he supplied to the Commission by
such investment trusts permits the detailed exposition of
data fully describing the trust, the trustees, the depositor,
and the sponsor.
Briefly summarized the requirements are
as follows:
A complete description of the instrument creating the
trust; the securities issued or to be issued; the securities
or property in the trust; the provisions, limitations and
conditions under which the estate is to be managed and ter­
minated; the relationships of the certificate holders, the
trustees, sponsor and depositor to each other and the estate,
etc., as to liens.
(If more than twenty-five per cent of the
total assets of the trust are in securities of the issuer or
a related company, then a schedule comparable to Registration
Form A -2 is to be supplied' to the Commission.
Copies of the
certified balance sheet and income statements of the trust
are to be inserted).
Full information as to the qualifications of the '
trustee; initial fee; continuing charges; removal, resigna­
tion, appointment of successors, duties and responsibilities.
19
Detailed description of the depositor; its directors
or partners; their relation to the trust; the securities in
it; underwriter of any of the securities; their duties and
responsibilities and the method of assigning their rights and
obligations.
(Certified balance sheet of the depositor is to
be attached).
When the sponsor is other than the depositor, the same
type of information is required of it.
The exhibits required (in addition to the financial
statements) are complete copies of the trust agreements, the
indentures, the certificates, the consent of experts to the
use of statements within the report, together with all other
pertinent contracts that will fully describe the issue.
Form D-l.
In registering certificates of deposit used
in anticipation of or in connection with a plan of reorganiza­
tion or readjustment, form D-l is to be usdd. If a plan of r e ­
organization or readjustment is proposed at the time the call
for deposits is to be made, parts I and II of form D-l are to
be filed at the same time.
If no such plan is submitted to
the security holders, part I is filed alone.
Part II is an
amendment of part I and as such becomes effective on such
date as the Commission may determine, having due regard to the
public interest and the protection of investors.
It is important to notice that the term "issuer," in the
case of certificates of deposit, signifies the person or
20
persons proposing to call for deposit the securities of an
oroginal issuer.
Sometimes the term "original issuer" is used
in connection with certificates of deposit.
That phrase
designates the person or persons who issued the securities which
are solicited for deposit.
Briefly summarized, the information called for in form
D-l is as follows:
A description of the original issuer and its business,
directors, and officers; stock and funded debt; the classes
of securities to be called for deposit; legal proceedings
pending; the underwriters; the persons soliciting the deposit
and the available financial information describing it.
The description of the committee; its employees and
agents; their interest in the original issuer; their qualifi­
cations and the restrictions and limitations upon their
business; and a statement as to why the deposit of securities
is desired.
Analysis of the provisions to disclose liabilities upon
all parties; method of accepting deposits and the extensions;
voting and borrowing privileges; termination; fees; expenses;
and the bonds and all collateral agreements to effect the plan.
Statement of the connection between the depository and
the issuer, and the committee; and analysis of the provisions
of the deposit agreement to disclose duties, responsibilities,
compensation and liabilities.
21
Exhibits required are:
the deposit agreement; the
form of the certificate of deposit; circulars used in solicit­
ing the deposit; all pertinent agreements, etc.; and the list
of persons to whom it is intended to make the call for deposits.
Form E-l.
This form is intended for use in reorganiza­
tions, but its use is considerably broadened by the definition
of reorganizations to include all readjustments, exchanges,
mergers, and consolidations and by the adoption of the form to
cover the issuance of securities including contracts of
guaranty.
Consideration of the applicability of form E-l requires
an understanding of the terms used by the Commission.
"The
Term1' reorganization" includes any transaction involving:
(a) the acquisition of assets of a person, directly or indi­
rectly^ ’partly or wholly, in consideration of securities dis­
tributed or to be distributed as a part of the same transaction
directly or indirectly to holders of securities issued by such
person or secured by assets of such person, whether as a
liquidating dividend or otherwise; (b) a readjustment by m o d i ­
fication of the terms of securities by agreement, or (c) a r e ­
adjustment by the exchange of securities by the issuer thereof
for others of its securities; or (d) the exchange of securities
by the issuer thereof for securities of another issuer; or (e)
a statutory merger or cnnsolidation.1
1 Federal Trade Commission Rule effective May 16,193^.
22
A ’’sale" Is defined as taking place:
(a) when an
opportunity to assent to or to dissent or withdraw from a
plan or agreement for reorganization is given on such terms that
a person so assenting or failing to dissent or withdraw within'
a limited time will he hound, as far as he personally is con­
cerned, to accept such securities, unless .at the same time he
retains or Is given a right subsequently to withdraw which Is
conditioned, if at all, only upon his payment of not more than
his proportionate part of the expenses of reorganization, and
(h) if the plan or agreement referred to is submitted by, or
with the authority of, the issuer of such seaurities.^
Use of form E-l is prescribed to register reorganization
securities under all conditions, even though such securities
are to be held by voting trustees and are to be represented by
voting-trust certificates, if such voting-trust certificates
are Issued or sold to the public (including in such term any
substantial class of security hplders, or their representatives).
A brief indication of the type of information sought
through form E-}. follows:
A description of the character, business, subsidiaries,
or parents, of the issuer of the securities.
The features of the reorganization plan and the details
with respect to each class of security holders, creditors, etc.;
2 Federal Trade Commission Buie effective May 16, 193^*
a full analysis of the capital structure prior to and after
completion of the reorganization plan.
A description of the officers, stockholders, voting
trustees, counsel, underwriters, committees; their compensa­
tion, qualifications, and relation to the registrant, prede­
cessors, or issuers; the expenses of the reorganization; the
cash to be obtained, from sales; its purpose; the usual de­
scription of the method of disposing securities to all parties;
unusual contracts; legal proceedings; denials by States of
rights to issue securities, etc.
When securities registered are based upon real estate,
the following is required:
The native of the interest, the
general use of the property, its occupancy, furnishings and
equipment liens, taxes; balance sheet on a date ninety days
prior to registration.
The sales price at which securities of the vendor were
traded on organized exchanges; full description of the securi­
ties; certified balance sheet ninety days prior to acquisition
of property or if securities are acquired, ninety days prior
to registration; and certified profit and loss and surplus
statements for three preceeding years.
Exhibits, other than financial, required are:
Certifi­
cates of incorporation or all papers pertaining to organization
latest annual report; certified orders of State regulatory
bodies; indentures and agreements pertaining to securities or
24
other properties; the deposit agreement and plan; and the
prospectus.
Form F-l.
form, when-:
The Commission requires completion of this
(a) an opportunity to assent to or to dissent or
withdraw from a plan or agreement for reorganization is given
on such terms that a person so assenting or failing to dissent
or withdraw within a limited time will he bound, so far as he
personally is concerned, to accept voting trust certificates,
unless at the same time he retains or is given a right sub­
sequently to withdraw which is conditioned, if at all, only
upon his payment of his proportionate part of the expenses
of reorganization, and (b) if the plan or agreement referred
to is submitted by, or with the authority of, the issuer of the
voting trust certificates.3
The data required in the registration statement for
voting-trust certificates includes a full description of the
issuer, the trustees, and the terms of trust agreement, par­
ticularly detailed to show the relationships of the trustees
to the organization; statement of their interest in and
employment in the organization; number and description of
securities to be held in trust; an analysis of the principal
provisions of the agreement as to termination, removal, suc­
cession, and liability of trustees; liability of any depository;
3 Federal Trade Commission Rule effective March 14,1934.
25
limitations upon the trustees; voting powers of the trustees;
methods in which the trustees vote; ability of trustees to
trade in the certificates registered or in the securities of
the corporation; compensation of the trustees and the deposi­
tory; methods of distributing dividends; and statement of any
denials by government bodies of the right to sell securities
issued by the trust.
There are required, as exhibits, copies of the trust
agreement and any certificates to be issued under it and any
pertinent contracts or indentures that bear upon it.
Wo
provision is made for the filing of any financial statements.
Forms G-l and G-2.
Fractional undivided producing oil
or gas royalties or rights are required to be registered on
form G-l.
The Commission has emphasized that the word "rights"
is sufficiently broad to require registration of interests
which are regarded as giving ownership of the oil or gas in
place as well as to interests which merely afford the owner
the right to produce oil or gas.
However, the Act applies only
to "fractional" interests; consequently the transfer of the whole
interest in any tract of land, though under the terms of the
lease the holder may be entitled only to a position of the
production, is not considered the transfer of a security so
as to require registration.
The registration statement calls for a description of
the registrant as to form of organization, and the details of
the tract of land which is underlain by the gas or oil wells.
In addition, the records of previous production as well as
future possibilities must be outlined.
Descriptions of the
outlets for disposition of the product, details of the lease
under which the royalty owners are to receive payments, r e ­
cognition of validity of the offeror's title to the products,
material contracts, liability to taxes, and denials of the right
to sell securities must all be fully disclosed.
-Among the
exhibits required is a plat of the tract and the surrounding
area to a distance of at least one-half mile from all sides,
showing the approximate locations and spacings, and the depths
of all producing, previously producing, and drilling oil or
gas welHs and of all dry wells.
Fractional undivided non-producing oil and gas royalty
interests are to be registered on form G-2.
A non-producing
royalty interest means any royalty interest not included in
the definition of "producing royalty interests" under form
G-l.
The registration statement is concerned with the customary
description of the registrant, size and price of the fractional
interests to be created, and analysis of the physical proper­
ties of the tract of land to which the interests apply.
This
mu^bbe supplemented with detailed information concerning the
nearest oil or gas producing tract within an area of two
miles, relative to its physical characteristics, present p r o ­
ductivity, and future prospects.
27
With respect to the property to which the interests
that are sought to he registered apply, the statement calls
for data concerning transportation- facilities, encumbrances
such as mortgages, deeds of trust and liens, details of the
lease, and an enumeration of the deductions to which the
royalties payable are subject.
Included among the exhibits
are a plat of the tract and the surrounding area encompassing
the producing wells mentioned above, a legal opinion as to
the validity of the title to the tract, specimens of the
instrument to be used to transfer or convey the royalty rights
or interests and copies of denials by governmental regulatory
bodies of the right to sell securities.
I
CHAPTER V
FINANCIAL STATEMENTS - PREPARATION AND AUDITING PROCEDURE
The Commission has distributed the form required to he
completed in describing the financial condition and results
of the operations of an issuer by virtue of its general power
to establish rules and specifications where statements are
deemed appropriate in the public interest and under the two
following sections of Schedule A of the law.
. . . a balance sheet as of a date not more than
ninety days prior to the date of filing of the regis­
tration statement showing all the assets of the issuer,
the nature and cost thereof, whenever determinable,
in such detail and in such form as the Commission shall
describe. All the liabilities of the issuer in such
detail and such form as the Commission shall prescribe
including surplus of the issuer showing how and from
what sources such surplus was created, all as of a
date not more than ninety days prior to the- filing of
the registration statement.
If such statement be not
certified by an independent public or certified
accountant, in addition to the balance sheet required
to be submitted under this schedule, a similar detailed
balance sheet of the assets and liabilities of the
issuer, certified by an independent public or certified
accountant, of a date not more than one year prior
to the filing of the registration statement, shall be
submitted;. . . .!
. . . a profit and loss statement of the issuer
showing earnings and income, the nature and source
thereof, and the expenses and fixed charges in such
detail and such form as the Commission shall prescribe
for the latest fiscal year for which such statement
is available and for the two preceeding fiscal years,
year by year, or, if such issuer has been in business
for less than three years, then for such time as the
issuer has been in actual business, year by year.
1 Securities Exchange Act, 193^* Paragraph 25.
29
If the date of the filing of the registration statement
is now more than six months after the close of the last
fiscal year, a statement from such closing date to
the latest practicable date. Such statement shall
show what the practice of the issuer has been during
the three years or lesser period as to the character of
the charges, dividends or other distributions made against
its various surplus accounts and as to depreciation and
maintenance charges, in such detail and form as the
Commission shall prescribe, and if stock dividends
or avails from the sale of rights have been credited to
income, they shall be shown separately with a statement
of the basis upon which the credit is computed.
Such
statement shall also differentiate between any recur­
ring and nonrecurring income and between any invest­
ment and operating income.
Such statement shall be
certified by an independent public or certified
accountant; . . . .2
Three kinds of registration statements require financial
statements:
(1) the ordinary issuance of securities, (2)
those of investment trusts, and (3) those used in case of r e ­
organizations.
In each instance the Commission has stipulated
forms to be used and supplementary schedules to be completed.
The following balance sheet accounts which must be
analyzed and full information aubmitted give an idea as to
the scope of the accountant's work:
Assets
Current Assets
Cash, on demand
Cash, time deposits
Call loans
2 Ibid., paragraph 26.
30
Notes and Accounts receivable:
Notes receivable (customers)
Not yet due
Past due
Accounts receivable (customers)
Not yet due
Past due
Other notes receivable
Other accounts receivable
Total notes and accounts receivable
Less reserve for doubtful notes and accounts receivable
Net notes and accounts receivable
Inventories
Materials and unfinished goods
Finished goods
Other current assets
Marketable securities
Indebtedness of officers, directors, stockholders,etc.
Indebtedness of subsidiaries and affiliates, current
Total current assets
Deferred Assets
Unamortized debt discount and expense
Stock discount and expense
Prepaid expenses
Other deferred charges (specify)
Total deferred charges
Other assets
subscribers to capital stock
Other (specify)
Investments
Securities of subsidiary and/or affiliated companies
Other investment securities
Indebtedness of subsidiary and/or affiliated companies
not current
Other (specify)
Total investments
Fixed assets
Property, plant, and equipment
Less reserves for depreciation and depletion
Net
Intangibles
Franchises
Patents and trade-marks
Goodwill
Organization expense
Other (specify)
Total intangible
Less reserves for depreciation and amortization
Net intangibles
Total assets
Liabilities, capital, and surplus
Current liabilities
Notes payable (trade)
Accounts payable (trade)
Notes payable (bank)
Serial bond or mortgage installments falling
due within one year
Accounts and notes payable to officers,
stockholders, or employees
Accounts and notes payable to subsidiary and/or
affiliated companies, current
Accounts due others
Accrued liabilities
Other current liabilities
Total current liabilities
Long-term debt (less in treasury)
Bonds
Mortgages
Notes
Indebtedness to subsidiary and/or affiliated companies
not current
Other (specify)
Total long-term debt
33
Capital stock (less stock in treasury)
Preferred
Common
Other (specify)
Total capital stock
Reserves (specify)
Surplus
Paid-in surplus
Capital surplus
Unrealized appreciation arising from revaluation
of capital assets
Proportion of undistributed profits and/or
surplus of subsidiaries (if accrued on
books of issuer)
Earned surplus (or deficit)
Total surplus
Total liabilities, capital, and
surplus
It is necessary to give supplementary information for
most of the above items.
In order for the accountant to
accede to the requirements of the Commission in the prepara­
tion of the necessary financial statements, a very detailed
audit of the books of the issuer would appear to be essential.
A break-down of requirements concerning balance sheet items
follows:
34
Cash
Cash Is divided Into two parts:
Cash on demand
Cash, time deposits
The definiteness of these suggests precise treatment
of these elements that are normally included in the cash of a
going concern In a statement of this character, in view of the
liabilities imposed upon the accountant.
tions advisable
Some of the precau­
are:^
1.
Unqualified certification of fluids by depositories.
2.
Elimination from the account of vouchers that may
normally be included in cash.
3.
Removal of stamps and foreign funds to some position
lower on the balance sheet.
4.
Study of the elements in transit, particularly those
that arise from related companies.
5.
Personal verification of funds in branch offices
instead of reliance upon certificates.
6.
Exclusion of funds in closed banks regardless of
possible liquidation.
7.
Detailed study of the collectibility of demand or
time deposits in country banks.
3 Form A -2 Instruction Book, pp. 26-28.
35
Call Loans.
Whether normal auditing practice of
procuring confirmations is sufficient is a problem here.
Undoubtedly the auditor should be responsible for the ascertain­
ment of the collectibility of a call loan by a reasonable study
of the position of the borrower.
Notes and Accounts receivable.
Aside from ordinary
audit procedure in the examination of notes and accounts r e ­
ceivable, it is reasonable to assume that, in order effectively
to state the accuracy of the accounts, the auditor is charged
with the obligation of confirming the propriety of balances
held.
It is obviously essential that any discounted, pledged,
or assigned accounts be properly referred to and that receivables
resulting from consignments or pre-dating of any character be
specifically identified.
Reserve for bad debts.
The issuer is required to state
in a separate schedule whether in its judgment all notes and
accounts receivable known to be uncollectible have been charged
off and whether adequate reserves have been provided for
doubtful notes and accounts.
Inventories.
A supplementary schedule is called for
in which the basis used in the valuation of inventories is to
be expressed.
When inventories contain profits resulting
from sales by affiliated interests, accurate or approximate
36
amount of such profits should he indicated.
The handling of the inventories should be in a manner
which will completely assure the auditor that the inventories
have been properly taken and priced.
This probably entails
the discarding of the normal practice of obtaining certificates
as toperformance -- regardless of the responsibility of the
individuals.
It becomes fairly evident that the auditor is
here charged with:
1.
Definite knowledge that the inventory has been
properly taken under his own supervision.
2.
Providing that the basis used for pricing as stated
in the issuer’s certificate is consistent throughout the e n ­
tire inventory or that differences are adequately noted; and
that the basis is carefully defined in order that problems of
pricing work in process, raw materials in a rising market,,
duties, transit, charges, insurance, trade or cash discounts,
etc., may be carefully cohered.
3.
Make certain that hypothecated materials are
plainly revealed.
4.
Seeing to-it that materials consigned to others
are priced on a basis consistent with the balance of the
inventory, giving due weight to allowances for losses, damages,
and expenses of possible returns; that materials received on
consignment are specifically excluded tod that post-dated, or
goods in transit are carefully ear-marked.
37
5-
Taking care that in pricing inactive or dead stock,
obsolete or damaged goods, broken lots, repossessed merchandise,
bases sufficiently conservative to be approved are employed.
Marketable Securities.
These are defined to be only
securities temporarily held for resale.
Those held primarily
for investment purposes are to be taken up in one of the sub­
sequent groups.
A separate schedule is required in which (a)
basis -of valuation is to be stated, and (b) the market value
of each security is to be stated.
Normal auditing procedure
would require:
1.
Ascertaining whether there is any hypothecation
of securities.
2.
Physically counting the securities or securing
unquestioned verification that such securities are legitimately
in the hands of others.
3.
Determining the completeness of the securities as
to registration and coupons.
4.
Fully proving title.
5.
Adequately separating or commenting upon securities
which are pledged as part of sinking or trustee funds.
6.
Substantiating cost.
Indebtedness of officers, directors, stockholders,
and others, current.
There is to be reported here the current
indebtedness from each officer, stockholder, and persons
38
directly or indirectly controlling or controlled by the
issuer, and persons under direct or indirect common control with
the issuer.
In addition, a supplementary schedule reporting
the names and amounts of indebtedness from each of the foregoing
is to be submitted when such debts to the issuer are in excess
of $20,000. , The shhedule is to state the purpose of the debt,
rate of interest received thereon, and a brief description of
the collateral securing the indebtedness, if any, held by the
issuer. ■If the item is not of a current nature, it is to be
included under "Other Assets."
Verification of these debts should follow the course
of procedure discussed in connection with other current r e ­
ceivables - - a definite confirmation of the balances, the
ascertainment of liens against them, and their fair valuation.
Indebtedness of subsidiary and/or affiliated companies,
current.
The accountant bears the obligation of examining
the subsidiary to ascertain the accuracy, collectibility, and
fair value of the accounts.
Unamortized debt discount and expense.
Under this title
a schedule is required stating the amounts of unamortized debt
discount and the expense applicable to each issue for which
costs are being amortized, the dates of the issues, the
maturities of the obligations, and the methods used in amor­
tizing such discounts and expense.
Failure of the amortization
39
to conform to accepted principles would require some
statement of the position of the auditor.
Stock discount and expenses.
While no schedule requires
that the content of this deferred charge he indicated, it is
presumed that any auditor certifying to a balance sheet with an
item upon it that covered the discount and expenses in the
issuance of the company’s own stock would adequately explain
the reasons for the maintenance of the account and would
ascertain its legality.
It is suggested in the case of reorganizations that
discounts should always he shown as a deficit or deduction from
capital, as the circumstances require, if they exceed ten per
cent of the par value of the shares of stock to which they
apply.
Prepaid expenses.
It is interesting to observe the
careful segregation in the balance sheet of deferred assets
and prepaid expenses despite the variance in accounting prac­
tice.
No schedule of these assets is called for, but the
issuer and the auditor are fairly charged with observing that
there are included within them only those accounts, falling
within that type of unabsorbed costs, which have a fair market
value and tangible existence (such as prepaid rent, unexpired
insurance, prepaid interest, and similar items).
Both the
issuer and the auditor bear the responsibility of including
40
such accounts at their fair going value.
Other deferred charges.
A supplementary schedule is
required in which all deferred charges are to he set forth
and explained and provisions for amortization detailed and
discussed.
Current practice normally includes within this
group deferred debts -- such as moving costs, experimental
expenses, unabsorbed advertising, promotional expenses
properly chargeable to succeeding periods.
The schedule raises
the presumption that the auditor and the issuer will agree as
to the propriety of the deferral and the reasonableness of the
provisions of the amortization.
If the auditor cannot approve
the continued maintenance of the balances or any part of them
under existing operating conditions, his responsibility to the
public necessitates unmistakable exceptions in the certifica­
tion.
*
Subscribers to Capital stock.
Here again the auditor
faces the necessity of verifying unpaid balances by correspon­
dence with subscribers shown upon corporate records to have
obligations incurred by reason of their desire to acquire
capital stock of the Issuer.
In addition, despite the cus­
tomary practice of stating such items at book value, there is
a problem as to the responsibility of an auditor in the ascer­
tainment of whether or not sufficient reserves should be
created to reduce the balances shown to a fair statement of
41
their value.
Securities of subsidiary and/or affiliated companies.
A schedule of the holdings of the issuer in such securities
is required stating the name of subsidiary and affiliated
companies and containing for each security:
1.
A brief description showing the number of shares
of stock, and the principal amount of bonds, notes, etc.,
he2d; the total shares of stock and principal amount of bonds,
notes, etc., outstanding; the ratio of each security held to
amount outstanding.
2.
The ledger value, the cost, the difference between
the cost and ledger value, if any; an explanation of the
difference between cost and ledger value, if any; and the
accounts with the respective amounts in which such differences
are now reflected.
3.
When such securities were acquired from affiliated
interests, a statement showing the respective costs to the
issuer and to each such affiliate, a brief description of the
transaction involved and the nature of the considerations
given or received in each.case.
4.
When such securities have been pledged to secure
mortgages, notes, or any other indebtedness, a brief statement
of the facts with regard to such pledges.
5.
When the practice of the issuer is to accrue on its
42
books a portion of the undistributed earnings of its subsi­
diaries, a statement of the amount and a schedule showing the
names of the subsidiaries and the amount of earnings accrued
with respect to each.
Aside from the normal and usual routine of:
1.
Ascertaining whether there is any hypothecation of
securities.
2.
Physically counting the securities or securing
unquestioned verification that such securities are legiti­
mately in the hands of others.
3.
Determining the completeness of securities as to
registration and coupons.
4.
Fully proving title.
5.
Adequately separating or commenting upon any secur­
ities which are pledged as part of sinkins or trustee funds.
6.
Substantiating cost for the issuer of all members
df the affiliated group.
The accountant must not shirk his responsibility of
ascertaining a fair market value of the securities unless it
is possible to qualify the certificate - - a n unusual step in
the statement of related securities.
Other investment securities.
The registration statement
attempts a careful distinction between marketable securities,
securities of subsidiary and/or affiliated companies, "other
investment securities," and "other investments."
The last
two are presumably composed of securities of those companies
which are not "effectively" controlled and which in the
regular course of business cannot and may not be readily and
quickly converted into cash.
A division of this group _into
classes affords an opportunity to divide securities of related
or associated companies from the type that are in no sense
concerned with the business of the issuer -- except possibly
as customers.
A supplementary schedule is required for the
first of this group, which will show for each security with
an aggregate cost equal to ten per cent of the total cost of the investment:
1.
Brief description
2.
Number of shares of stock held
3.
Principal amount of bonds, notes, etc., held
4.
Cost
5.
Ledger value
6.
Market value at dates of balance sheets
or nearest available date thereto, giving dates.
The others may be described as miscellaneous securities
without further detail and only their combined total cost and
market value need be shown.
When securities have been a c ­
quired from affiliated interests, a statement of costs to the
issuer and to its affiliate, a brief description of the transac
44
tion involved, and the nature of the consideration given or
received in each case are also required in addition to a state­
ment of amounts of and all pertinent facts with regard to such
securities as have been pledged to secure mortgages, notes,
and. other indebtedness.
The problem of ascertaining that the values expressed
within this statement represent the reasonable worth of the
securities is obviously present here.
Indebtedness of subsidiary and/or affiliated companies,
Not current.
The registration statement requires a statement
showing the following:
1.
Name of debtor corporations
2.
Amounts due therefrom
3.
Brief description of the purpose of the
creatinn of the indebtedness
4.
Statement as to whether collateral is held
by the issuer to secure said indebtedness and
the nature thereof
5.
Rate of interest receivable on indebtedness.
It is quite-evident that the accountant must adequately
examine the records of subsidiary and affiliated companies
directly or indirectly controlled by the issuer or under
direct or indirect common control with the issuer in order
to reasonably satisfy himself as to the accuracy, collectibility
45
and fairness of the issuer's value referred to under this
title.
Other investments.
The registration statement does
not require an analysis of these miscellaneous securities
hut the principles described in the discussion of the securi­
ties of subsidiaries above seems to apply thoroughly to this
group.
Property, plant, and equipment.
A supplementary
schedule is required to be included in the registration
statement to show the following analysis for each of the major
classifications of the property, plant, and equipment accounts
from the time of organization of the issuer or if that is not
practical, beginning with January 1, 1922.
1.
Ledger value of each of the major classifications
2.
Cost to issuer
3.
Profits to affiliated interests included
therein (if any).
If profits of this nature
are included in fixed assets, full details,
including a brief description of the property,
the name of the affiliated interests from
whom acquired and the cost of the property
to such affiliated interests, are required.
4.
Unrealized appreciation or write down resulting
from revaluations, reorganizations, mergers,
or otherwise.
If any such appreciation or
write down is included or excluded in fixed
assets, a statement is to he submitted showing
the nature of the transaction giving rise to
them, including (a) in the case of appraisals:
dates of appraisals, the basis thereof, the
name of the appraiser, and a comparison of
the previous ledger value and appraised value
of the property, and (b) in the case of mergers,
consolidations, reorganizations, etc., a
comparison of the recorded values on the books
of the respective vendors and vendees.
5.
Bond discount, commissions, and expense (if
any) included therein other than that properly
allocable thereto for the construction period.
6.
Stock discount, commissions, and expense,
if included.
This schedule is not to include intangible items such
as franchises, patenst, and trade-marks, goodwill, organiza­
tion expenses, etc.
If any important item of the property, plant, or
equipment of the issuer has been definitely abandoned and
not written off, the value of the property within the fore­
going schedule (or an estimate if the amount is not known)
is to be stated.
47
Issuers owning raining, oil, and similar businesses
which have incurred expenditures in development, stripping,
drilling, and costs of similar nature, which are included
in the cost of property, plant, and equipment are specifi­
cally required to set forth in a separate schedule the
nature and amounts of such elements and the basis for their
ex tinguishment.
Obviously, completion of this analysis together with
detailed explanations of differences between their cost and
ledger values will materially aid the issuer in assigning the
reason for the valuation of the property, plant, and equipment
upon the balance sheet.
Yet, the schedules do not begin to
cover the obligations of the auditor to establish title and
value.
The Commission has taken the position that accountants
whose experiences do not qualify them as appraisers of the
particular property included in the registrant's balance
sheet should neither assign values to such properties nor
certify to the accuracy of the valuations placed on such
properties.
That is the job of the appraiser, not the
accountant.4
Greidinger, B. B . , Accounting Requirements of the S.E.C.
(New York:
The Ronald Press', 1939) P* iBl.
7
Assuming that there are to be no qualifications as to
the property, the accountant is probably charged with quali­
fying or ascertaining:
1.
That title to all of these assets is unmistakably clear upon the records in county or
State offices recording such facts,
2.
That the public record of liens, such as
mortgages,
judgments, taxes, assessments,
etc., is properly reflected in other parts
of the statements,
3.
That all deeds and other instruments of title
are in possession of the issuer and agree
with the public records,
4.
That the land and building purchase accounts
follow the ordinary definition of such assets
and contain generally the cost of abstracts,
appraisals, plots and surveys, examination
and registration of title fees, conveyancer's
and notary fees, contract price, legal fees,
commissions paid to brokers, assessments for
public improvements which add to value of
property, the cost of wrecking old buildings
on property, and finally, the cost of real
improvements to the land, insurance, taxes,
and interest during construction.
5-
That the Building Construction account follows
the ordinary definition and contains generally
the cost of permits, licenses; costs of wreck­
ing old buildings (less salvage); expense in
removing tenants from premises; legal, archi­
tectural, and engineer's fees; cost of testing
piers, foundations; labor, materials and
supplies; contract work, insurance, taxes,
and interest during construetion,
6.
That equipment costs follow the normal
definition and contain only contract costs,
installation, and freight charges,
7.
That assets of record are actually in possession
or control of the issuer and that all assets
which have been dismantled, destroyed, trans­
ferred out, sold, or otherwise disposed of are
excluded from the record or reported upon.
This will undoubtedly require the unusual step
of listing the physical assets and inspecting
them.
8.
That unless an appraisal has been had of the
property, and unless full expression of the
source and figures in the appraisal is had by
issuer so that it may be adequately referred
to by the accountant, a reasonable survey of
50
assets by appraisers employed by the accountant
ascertains that the balance sheet sets forth
a fair statement of going value.
Reserves for depreciation and depletion.
An explana­
tion of the rules followed by the issuer in the computation
of the amount charged off for depreciation or depletion is
to be submitted.
It is to be in a form which will show
separately the amounts and classes of property subject to
depreciation and depletion, the rates of depreciation or d e ­
pletion used, the pertinent facts upon which the rates are
based and a comparison of depreciation and depletion claimed
to have been sustained for the purpose of Federal income taxes
and the amounts accrued through charges to income and/or
surplus.
This
information is to be submitted for each year
for which Federal income tax returns have been filed.
While this process enables a full expression of all
pertinent facts, it does not relieve the accountant of the
burden of:
1.
Determining if the rates of depreciation are
adequate, by an examination of the rates
used in comparable business and by a detailed
study of operating conditions that increase
or decrease normal depreciation.
2.
Satisfying himself that the reserve in the
51
'
aggregate and in its detail is adequate as
a measure of the loss for "both (a) wear and
tear, and (b) obsolescence and inadequacy.
5.
Stating exceptions to the process if that is
found necessary.
Where the rates of depreciation used for period of the
report are substantially different from those used in the
preceding accounting periods, such change will undoubtedly
affect proper comparisons of the present accounting period
with the preceding accounting period.
In order for a company
to show either increased or decreased earnings, it can simply
change its rates of depreciation from year to year so as to
accomplish its ends.
Where the rates of depreciation applied
for the accounting period of the report submitted are different
from the rates applied for the prior accounting periods, then
that fact is required to be disclosed together with details of
the differences.5
The Commission is definite in its instructions to
accountants regarding changes in accounting methods.
If any
change in accounting principle or practice has been made
during the period covered by the profit and loss statements
and such change substantially affects proper comparison with
the preceding accounting period, give the necessary explanation
5 Ibid., p. 212.
52
in a note attached to the appropriate balance sheet or profit
and loss statement.^
Intangibles.
The balance sheet divides intangibles
into franchises, patents and trade-marks, good-will, organiza­
tion expenses, and other intangibles.
In addition it requires,
through a supplementary schedule, a brief description of the
nature of each class of Intangibles; a comparative statement
statement of the cost and ledger value of each class since
January 1, 1922, and a complete explanation of the differences,
if any.
If there are organization expenses capitalized or
deferred here, a statement is required beginning with January
1, 1922, of the nature and amount of each class of such costs.
While earnest application to schedules of this type
does seem to permit a complete analysis of the method in which
the intangibles have been built up, they omit all opportunity
for an explanation of a value ascribed.
Here, therefore, if
other experts cannot be relied upon to express a basis which
may be referred to by an accountant in his certificate, it is
essential that the Issuer and accountant express an attitude
toward the values or permit the assumption by the reader
that they approve the
basis as fair.7
The obligation of ascertaining that equitable title
7 Form A -2 Instruction Book, p. 36 .
to
53
intangibles lies with the issuer brings many problems when
reports of other experts independent of the issuer are now
available.
If that is assumed, it is probably necessary that
the auditor:
1.
Determine by active inspection through his
own staff or counsel that all franchises,
patents, trade-marks, goodwill, and other
intangibles have been legally assigned to the
issuer and registered in the Patent Office or
other public offices applicable.
2.
Thoroughly investigate the status of actions
which have been or will be started against
the issuer for patent infringements or denial
of ownership of intangibles.
3.
Determine that intangibles if expressed at
cost include only the fair cost of the elements
as they are ordinarily approved and particu­
larly do not encompass such elements as the
legal and incidental expenses incurred in
O
defending the issuer’s title and interest.
In addition to the analysis of intangibles, the regis­
tration statement requires an indication of the methods used
8 In the matter of LaLuz Mining Corporation, 1 S.E.C.
19, Pile Ho. 2-1223, October 4, 1935, p. 236 .
5^
in creating any reserve for their depreciation or amortiza­
tion.
It is to state the basis of providing the reserve and
the rates of depreciation or amortization used for each class
of intangible beginning with January 1, 1922.
It Is presumed, of course, that there are directed
principally to patents and trade-marks.
The auditor is
charged with ascertaining that the method of amortization
fairly distributes the cost over the period from the date
of the statement to the termination of their legal life,
unless:
1.
Such patents have been superseded by other
patents or have no further commercial value,
in which instances, of course, the accountant
is fairly charged with the necessity of
referring to that fact or eliminating the ele­
ments from his statement.
2.
There is a reasonable basis for failure to
amortize successful patents In that the
monopolistic condition established by the
patent has become perpetuated in the form of
goodwill, in which event a definite statement
of the condition is essential.
In addition, it should be recognized that, unless
this schedule fully covers the amortization of terminable
franchises during the period of the grant (regardless of the
55
possibility of renewal)
any other intangible
and the periodical elimination of
(subject to exhaustion) over the
determinable period, the' accountant is charged with eliciting
reference to them in his certificate or this schedule.9
Liabilities.
Current liabilities to be detailed
upon the balance sheet are:
Notes payable (trade)
Accounts payable (trade)
Notes payable (banks)
Serial bond or mortgage installments falling due
within one year
Accounts and notes payable to officers, stock­
holders, or employees
Accounts and notes payable to subsidiary and/or
affiliated companies, current
Accounts due others
Accrued liabilities
Other current liabilities
Supplementary schedules are required only in the case
of the accounts and notes payable to officers, stockholders,
and employees showing:
9 In the matter of Snow Point Mining Company, 1 S.E.C.
55, File No. 201522, March 14, 1956. p. 516.
56
1.
The names and amounts of accounts and notes
payable in excess of $20,000 each to each
officer, director, stockholder, and person
directly or indirectly controlling or controlled
by the issuer and persons under direct or i n ­
direct common control with the issuer.
2.
The purpose thereof.
3.
The rate of interest paid thereon
4.
A brief description of the collateral (if any)
given by the issuer to secure the indebtedness.
In the case of current debts to subsidiary or affiliated
companies, the following information is called for:
1.
Name of creditor corporations
2.
Amounts due thereto
3.
Brief description of the purpose of the
creation of the indebtedness
4.
Statement as to whether collateral was given
by the issuer securing said indebtedness and
the nature thereof
5. .Rate of interest payable on indebtedness.
The balance sheet requires a statement of long-term
debt (any obligations due after a year from the date of the
balance sheet) divided into the following classifications:
57
1.
Bonds
2.
Mortgages
3.
Notes
4.
Others (specify)
5.
Indebtedness to subsidiary and/or affiliated
companies, not current
In addition, the registration statement calls for an
analysis beginning January 1, 1922, with respect to the first
four of the foregoing obligations, of the following informa­
tion:
1.
Brief discription
2.
Nature and amounts of consideration received
3.
Discounts suffered
4.
Commissions paid and to whom
5.
Purpose of issue
6 . Methods employed in disposition
7.
ofsecurities
Details of sales through subsidiary
and/or
affiliated companies.
In the case of non-current debts to subsidiary or
affiliated companies, the same information is called for as
in the case when indebtedness is of a current nature.
Contingent liabilities.
The material contingent lia­
bilities of the issuer are naturally required to be stated
58
in full.
The obligation of the auditor will force statement
in extreme detail of every commitment that has any possibility
of becoming a direct liability.
Some illustrations of that
type are published by the Commission.
These and other normal
contingent worth full consideration, and which, when present,
undoubtedly require comment, are as follows
1.
Discounted acceptances - bank or trade
2.
Discounted drafts
3.
Indorsements of unrelated commercial paper
4.
Notes receivable discounted
5.
Customer's notes sold or otherwise trans­
ferred for value
6 . Accomodation indorsements
7.
Advances received on sight drafts with bills
of lading attached
8 . Agreements to purchase securities
9.
Assignment or hypothecation of receivables
without full release of liability
10.
Current mortgage liability of subsidiary
company on properties acquired
11.
Failure to redeem portion of preferred stock
on date stipulated
10 Form A -2 Instruction Book, p. 63 .
59
12.
Foreign exchange purchased for future delivery
commitments
13.
Necessity of converting stobk into bonds of
the c ompany
14.
Guarantor of accounts of others
15*
Guaranties of bonds and mortgages
16.
Payments required under employees’ pension
agreements
17.
Guarantor of interest on bonds of other
companies
18.
Guarantor of contracts of other companies
19.
Guarantor of rental agreements of affiliated,
and subsidiary companies
20.
Indorser of notes of subsidiary and affiliated
companies
21.
Guaranties of price maintenance
22.
Claims by customers or others for damages,
imperfections, delays, short shipments, etc.
23.
Lawsuits threatened, pending, or adjudicated
in lower courts against the company for
infringements of patents, copyrights, etc.,
claims for damages by officers, employees,
for compensation, etc.
24.
Unfavorable leases
25.
Unfilled contracts which in the judgment of
the management may adversely affect the issuer
26.
Commitments In excess of current market prices,
which in the judgment of the management may
adversely affect the issuer
27.
Agreements for guaranteeing product, quality,
service, and suitability
28.
Agreements for return of containers of products
29 . Unaudited Federal or State tax returns
30.
Unpaid portion of stock owned bpt not paid for
In full
31.
Agreement to subscribe to capital of subsi­
diaries or others
32.
Amount of cumulative preferred dividends accrued
but not yet declared! and the amount of arrears
per share
33*
Possible penalties in excess of profits upon
construction projects or other activity r e ­
quired to be 'completed in a specified time
34.
The default of sinking fund Installments r e ­
quired by the deed of trust applicable to
bonded indebtedness.
61
From the foregoing it is evident that the auditor must
make a full and detailed analysis of all contingent liabilities
in order to give complete expression to any such items.
Form
A -2 contains the following:
. . . As to matters set forth herein which rest
peculiarly in the knowledge of the person whose
statement is furnished and are not reflected by its
books and records, the accountant may make such ex­
ception as accord with the circumstances.
As to
matters required . . . to be set forth other than
(obligations of the person whose statement is fur­
nished as a party secondarily liable which are not
shown in the balance sheet) . . . there shall be
stated only those matters which, in the view of the
circumstances of the particular person whose state­
ment is furnished, are consequential; matters which, in
the view of the circumstances of the particular person
whose statement is furnished, are of an ordinary nature
are not to be set f o r t h . H
One might reasonably summarize the procedure required
of an auditor in proving debt (in addition to that pursued
in normal accounting and auditing practice) to include at
least:
1.
Thorough audit of the records of subsidiary
and/or affiliated interests.
2.
Unquestioned confirmation statements .
giving the complete information concerning
liabilities, and the assets pledged there­
under.
11 Form A -2 Instruction Book.
3.
Examination of the public records to ascertain
the full record of debt.
4.
Examination by counsel of all indentures,
of'the deeds of trust, mortgages, etc., in
order that full expression of the liabilities
may be had.
5.
Examination by counsel as to whether any of
the indebtedness exceeds any statutory, charter,
by-law or deed-of-trust, sinking-fund, etc.,
provision limiting the corporate indebtedness.
6.
Determining the accuracy by direct and personal
confirmation of all trustees1 accounting as
to bonds and notes under their supervision.
Reserves.
A supplementary schedule is required setting
forth with regard to each reserve:
1.
Brief description of the nature
2.
How formed, whether through charges to income,
earned surplus, or otherwise
3.
Summary of the credits to each reserve and.
the details
4.
Whether funds have been set aside to provide
for the objects for which the reserve was
created
5.
If contingent, the nature of the contingency
63
expected to arise; and the method by which
determination has been made of the amounts
accrued to the reserve.
There are to be included here all segregations of
past or current profits or surplus which are not for:
1.
Depreciation and depletion of fixed assets
2.
Depreciation and amortization of intangibles
3.
Depreciation of investments
4.
Provision for doubtful accounts and notes
Capital stock.
The registration statement requires
a schedule for each class of stock authorized and/or issued
containing the following:
1.
Brief description
2.
Par value per share
3.
If no.par value, give the stated or
assigned
value per share
4.
Number of shares authorized with dates
5.
Number of shares nominally issued
6.
Number of shares reacquired and in treasury
In addition, for the period beginning January 1, 1922,
the following information is required:
1.
Net number of shares actually outstanding
2.
Nature and amounts of consideration
3.
Commissions paid and to whom
received
4.
Expenses of issue
5.
Net proceeds of issue
6.
Purpose of issue
7.
Methods employed in dispositionoof stock
8.
Details of any sales of stock, made through
a subsidiary and/or affiliated company
Outstanding stock under the Commission’s rules excludes
that in the treasury but includes the stock pledged and out­
standing.
Treasury stock is to be shown as a deduction from
outstanding issues.
Certainly schedules of this type (properly reconciled
with existing book values of the capital accounts) permit a
full disclosure of all matters regarding the issuance of
capital and the valuation placed upon them on the company's
records.
Whether, in addition, the auditor is reasonably
charged with the necessity of procuring opinion of counsel
as to the validity of the stock issued in accordance with
the certificate of incorporation, the by-laws, and the minutes
is a problem to be settled in each case.
For the auditor, too,
there is a question of the certificate as to issued stock that
can be secured from registrars and transfer agents if a,dequate
examination cannot be made of the corporate records.
Surplus.
The surplus accounts are to be stated so as
to show the record of:
65
1.
Paid-in surplus
2.
Capital surplus
3.
Unrealized appreciation arising from revaluation
of capital assets
4.
Paid-in
excess of the
Earned surplus (or deficit)
surplus is to include here notmore than
proceeds from the
the par or stated value thereof.
the
sale ofcapital stocks over
Here also are to be included
surpluses arising from recapitalization of business.
Foreign
elements sometimes called paid-in surplus, particularly donated
surplus or that resulting from appreciation of properties,
are to be stated elsewhere.
Capital surplus is not defined but, by both elimination
and good practice, it must be presumed to exclude paid-in
surplus, that surplus arising from unrealized appreciation
of capital assets and the surplus resulting from profits.
Obviously, therefore, it excludes surplus secured from such
sources as the sale of capital stokk at a premium but may
include that resulting from other dealings in a corporation’s
own stock, or donated stock, and transfers from the capital
accounts upon reduction of stated or par values, etc.
The instructions make no attempt to define for the
reader the distinction between capital surplus and paid-in
surplus.
However, where the surplus created represents the
excess of the amount received over the par or stated value
66
of the company’s capital stock, such excess is paid-in
surplus and should he so labeled in the balance s h e e t . H
The surplus arising from revaluation of capital assets
is to include the surplus resulting from the revaluation of
capital assets through unrealized appreciations or write­
downs incident to revaluations, reorganizations, mergers,
or otherwise.
This will, in part at least, correspond to
the data required by the Commission in the analysis of the
property, plant, and equipment accounts.
The undistributed profits of subsidiaries permit
segregation of the undistributed profits of subsidiaries as
a separate element when the accounting procedure of an
organization permits their accrual upon its records.
Earned surplus is the balance of net profits after
deducting the distribution to stockholders and the transfers
to any of the foregoing capital or reserve accounts.
Schedules analyzing the surplus are required:
1.
Capital surplus - a statement of the nature
and amounts of items in the account, including
donated surplus, discount on capital stock
reacquired, and any other elements not properly
included in the other specific surplus accounts.
2.
Unrealized appreciation, etc., a schedule of
the accounts and their respective amounts in
3-1 Greidinger, op. cit., p. 285 .
67
this item as a result of revaluations, etc.
3.
Undistributed profits of subsidiaries a schedule of the amounts so included which
were not distributed by the subsidiaries as
dividends or otherwise actually received by
the issuer.
In addition the issuer is speci­
fically directed to state the amount of any
surplus of subsidiaries at the dates of a c ­
quisition by the issuer.
4.
Earned surplus - aside from a detailed analysis
of the account for at least three years, a
statement is to be furnished bf the respective
amounts, if any, included in earned surplus
of stock dividends and stock rights, in excess
of the net profits derived from subsequent
sales of these and the basis for any such
inclusion.
Profit and loss and earned surplus accounting.
Profit
and loss and earned surplus statements are to be furnished for
the last three years of existence.
If the date of filing the
registration statement is more than six months after the close
of the last fiscal year, an additional schedule is required
to the latest practicable date.
In addition supplemental
schedules analyzing some of the elements are to be submitted.
68
The form adopted for the profit and loss and surplus
statement, with an indication of additional detail which is
made a part of the registration statement, is as follows:12
PROFIT AND LOSS STATEMENT
Income from Trading, Manufacturing, or Extracting
Gross Sales (less returns and allowances) - a
schedule is to he furnished of the major classes of
gross sales segregating sales to affiliated interests
(as defined in the balance sheet).
Cost of Goods Sold (exclusive of expenses specifi­
cally set forth below) - if intercompany profits are
included in this item, statement of the approximate
amount is to be made if unable to report the exact
amount thereof.
GROSS PROFIT
Selling, General, and Administrative expenses
Provision for Doubtful Accounts
Maintenance and Repairs
Rents and Royalties (classified in a separate schedule)
Other Expenses (classified in a separate schedule)
Taxes (other than Federal or State Income Tax).
Provision for Depreciation and Depletion
Total cost of Goods sold and Expenses
Gross Income from Trading, Manufacturing, or
Extracting
Operating Income Other than Trading, Manufacturing, or
Extracting
Operating Revenues - the major sources of operating
revenues and the amounts thereof are to be
stated
12 This is the form prescribed for ordinary registra­
tions (A-2).
69
General and Administrative Expenses
Maintenance and Repairs
Rents and Royalties (classified in a separate
schedule)
Commissions and fees - a statement indicating
to whom fees were paid for management,
engineering, underwriting, financial, and
other supervisory services, respective
amounts thereof, and the basis for such
charges is required
Other operating Expenses
Taxes (other than Federal or State Income Tax)
Provision for Depreciation and Depletion
Total Expenses
Gross Income other than trading,
manufacturing, or extracting
Total Operating Income
Income from other than Operations
Dividends received from subsidiary and/or
affiliated companies - an itemized statement
is required of dividends received from each
class of stock of each subsidiary and/or
affiliated company, the annual rate or amounts
received per share, the amount received in
stock and cash or in any other way.
In case
of dividends received in stock, the basis of
valuation employed in recording receipts
thereof is to be explained, the corresponding
amounts at which stock dividends were charged
against surplus of the issuing company, and
the class of surplus so charged
Dividends received from others - if stock dividends
are included, the companies from which said dividends
were received are to be named, the amounts stated,
and the basis fo valuation employed in recording
receipt indicated.
Interest received on long-term debt of subsidiary and/or
affiliated companies
Interest received bn long-term debt of others
Interest received on notes and accounts of subsidiary
and/or affiliated companies
Interest received from other sources (classified in
a separate schedule)
Commissions and Pees received - a statement indicating
from whom fees were received for management,
engineering, underwriting, financial, and other
supervisory services, the respective amounts thereof
and the basis for such charges is required
Profit on sales of securities
Miscellaneous other income (classified in a
separate schedule)
Expenses in connection with income from other
than operations (detailed in a separate
schedule)
Net Income from other sources than Operation
Non-recurring Income
Non-recurring income - a brief description of the
amounts included in this item is required.
In cases of income derived from sales of securi­
ties, properties, etc., to subsidiary and/or
affiliated companies, the cost to the issuer,
the consideration and nature thereof received,
and the profit recorded is to be shown in a
schedule.
If profits or losses from thes
sale of capital stock received as dividends
or the sale of rights are included, the basis
of computing the amounts thereof is to be
set forth
Non-recurring Expenses and/or Deductions (specified
in detail as above)
Net Non-recurring Income and Expense
Total Gross Income .
Deductions from Gross Income
Interest on long-term debt
Interest on notes and accounts payable to subsidiary
and/or affiliated companies
Amortization of debt discount and expense
Other deductions (specify)
Total Deductions
Net income before Federal and State Income Taxes
Federal and State Income Taxes
Net Income
71
EARNED SURPLUS
Balance beginning of period
Net Income as above
Total
Dividends paid
On preferred stock
In cash
In stock
On common stocks
In cash
In stock
Total dividends paid
Net
Other credits to earned surplus (specify in detail)
Total credits to earned surplus
Other charges to earned surplus (specify in detail)
Total other charges to earned surplus
Balance in earned surplus at end of year.
CHAPTER VI
LIABILITIES AND RESPONSIBILITIES OF ACCOUNTANTS
UNDER THE ACT
The Act renders any person whose profession gives
authority to a statement made by him, and who has with his
consent been named as having prepared or certified any part
of the registration statement, liable to any person acquiring
a security for any misstatement or omission in the part of
the registration statement prepared or certified by him.l
Since the presence of the consent in the registration state­
ment may be waived by permission of the Commission, in such
case actual consent to the use of the report must be
shown.2
A brief analysis of the liabilities of accountants
under the Act Is as follows:
1.
Their obligations t© purchasers are confined to
losses resulting from material untruths or omissions in their
portion of the data in the registration statement.^
2.
Damages may be minimized by showing that the whole
or part of the loss resulted from other than the untruth or
omission.^
1 Section 11(a); Par. 9-7
2 Pars. 5*19
^ Par. 9.7
^ Par. 9.22
9.7
73
3.
The purchaser need not have knowledge of their
certification or have relied upon it in anyway.5
4.
There is no escape from liability by the employ­
ment of irresponsible dummies as parties to a registration
statement.6
5.
The remedies of a purchaser in an action under
the Federal law are in addition to those accorded to them
under common law and State statutes.7
6.
Suit must be commenced in the case of an untruth­
ful statement or omission in a registration statement,
within one year after discovery of the untruth or omission,
or from the date, when in the exercise of reasonable diligence
it should have been discovered, and in no event later than
three years after the public offering of the security.8
7.
An attempted waiver by the purchaser of his right
to proceed against an expert for an untruthful statement or
omission is ineffectual.9
8.
Every expert liable for a misstatement or omission,
unless guilty of a fraudulent misrepresentation in the
5 Par. 9.4
6 Par. 10.4
7 Par. 9-33
8 Par. 9-34
9 Par. 9*39
74
registration statement filed, for a particular security, is
responsible jointly and. severally with all other persons
rendered liable under the Act to any purchaser of such
security.
Each person so held liable may demand that the
others against whom liability attaches under the Act, share
in his costs and damages.-*-®
The defenses to an action against the accountant or
other expert based upon misstatements or omissions in the
registration statement are:
1.
at the
The
purchaser's knowledge of the truth
oromission
time of acquisition of a security.
2.
The existence of an earning statement covering a
year beginning
after the effective date of registration and
acquisition by
the purchaser in reliance upon that statement.12
3.
The
reliance upon a rule or regulation
ofthe
Commission.13
4.
The severance of relations with the issue or
attempted severance with
expert. I1*'
10 Par. 9.26
11 Par. 9.10
12 Par. 9.12
13 Par. 9-13
I1*- Par. 9.14
due notice to the Commission by the
75
5.
The taking effect of a registration statement
without knowledge of the expert, followed by a severance or
attempted severance and due notice to the Commission and the
public .3-5
6.
Reasonably grounded belief in the truth of and
absence of omissions in report after reasonable investigation,
(in the case of accountants this means that his statements
or reports represent the application of accepted accounting
procedure to the facts disclosed in the investigation).3-6
7.
The report or certificate was used without his
consent. 3-7
8.
The extracts or copies of his reports were not
fair representations of the originals.3-8
9.
Reliance upon that part of the registration state­
ment prepared by other experts or upon that part of the
registration statement purporting to be a copy of a public
document.3-9
The problems confronting accountants and other experts
who are open to liability to the investing public for matters
3-5 Par. 9.15
16 par. 9.16
17 par. 9.18
18 Par. 9.17
19 Par. 9*19
inaccurately reported upon "by them involve a number of
elements, particularly the extent of the examination, quali­
fications of statements made, and the indemnification that
may be secured.. The Act effects no change in current prac­
tice as to the work of those designated as experts.
It does,
however, add liabilities beyond those ordinarily understood
to adhere to the client - practitioner relationship.
It
imposes3upon experts the necessity of rendering their services
in such a manner that not only the client but any investor
will be able to allege that any part of their rreport is u n ­
true or omits material facts which should have been stated
to effect a full disclosure in the report.
It bases liability,
as far as experts are concerned, upon (l) Statements prepared
after reasonable investigation but so framed as to be m i s ­
leading;
(2) Statements that are misleading since they were
prepared without reasonable investigation.
It is not essential that the expert be proved reckless,
incompetent, or in collusion with the issuer.
He may be
liable for failing to extend his examination far enough before
rendering his report or for misleading statements prepared by
an honest but erring subordinate.
Under such conditions the accountant should refrain
from the acceptance of engagements unless every opportunity
is given to make a detailed examination, with little of the
customary restrictions as to time and fees.
Self-protection
77
demands that accountants have a thorough understanding of
the nature and use to be made of the report, and an agree­
ment with the issuer that is to be cited in full within any
registration statement.
Working papers used on the engage­
ment should be carefully preserved and should effectively
state the basis for preparation of the report - the books
or sources used, the officers or employees of the issuer or
others consulted, and the name of the subordinate preparing
the paper.
Accurate time reports to establish "reasonable
care" are essential.
The statements, certificates, and supplementary
schedules prepared for the report, will bear considerable
rechecking for headings, clarity, and amplification, with the
fact borne in mind that the investor is not expected to be
familiar with legal, accounting, or appraisal practices,
and that abridgment, verbosity, and ambiguity are all likely
to be condemned.
By far the most important part of the report is the
certificate.
There is no prohibition in the statutory p r o ­
visions regarding the behavior of an expert which denies himthe right to refuse to' certify to matters beyond his knowledge
or the restrictions of his engagement.
On the contrary, both
the Regulations of the Commission and the forms issued by
them for use in registration, fairly bristle with the cordial
invitation for the expert -- more particularly the accountant -
78
to divulge all of the extraneous considerations that prevent
his unequivocal certification of the facts presented.
Many
investors will regard these qualifications as the most i m ­
portant sources of information within the registration state­
ment .
If it, is assumed that a report definitely indicates
the source of its information, an expert can successfully
defend an action "by showing that he had no reasonable ground
to believe and did not believe that there was any untruth or
omission in the report of another expert or in a statement
purporting to be that of a public official.19
If an expert
satisfied himself as to the knowledge and skill of another
expert upon whose statement or report he relied, qualifying
his report by reference to such other expert, and does not
actually know or have any suspicions of an untruth or omission
on the part of such other expert, he has satisfied the statute
and can successfully defend the action.
If, for instance,
an attorney, acting as an expert in connection with the r e ­
gistration statement, is responsible for a statement that
certain property, title to which may be in litigation, belongs
to the issuer, an accountant may fairly indicate that he has
relied upon this statement or opinion and certify, with
comments, to the correctness of a balance sheet including
19 Par. 9*19
this property as an asset.
It is not essential that the
opinion of the attorney he reviewed by the accountant, as
he may reasonably rely upon the conclusion.
It is only in
those cases where he actually believes or has reason to
believe that the attorney is in error that he is not entitled
to rely upon the statement.
Obviously an expert may be on
safer ground when he makes no Inquiry into the basis for the
facts or opinions of another expert than when he attempts to
review the details giving rise to the statement of a fact or
opinion, because in the latter case he may discover informa­
tion which, though not definitely conclusive, may raise
doubts in his mind as to the correctness of the other expert’s
statements.
The Act does not insist upon this type of check­
ing and it would seem advisable to avoid it wherever reasonably
possible.
It is difficult to draw a line sufficiently clear to
indicate where the functions of an accountant stop and those
of an attorney or appraiser begin.
The principle of reliance
of one expert upon another's statements brings up the ques­
tion of the respective limitations of the several professions.
It would seem logical that, should an expert slightly over­
step his functions and state a fact or opinion which properly
should have come from another expert, reliance upon such a
statement should be an effective defense because it is generally
recognized that the different professions overlap.
But one
expert may not rely upon the opinion of another when it is
clear beyond any doubt that the latter has overreached the
bounds of his profession in advancing a statement.
B I B L I O G R A P H Y
BIBLIOGRAPHY
A ..Books
Greidinger, Bernard B., Accounting Requirements of the S .B.C.
New York City:
The Ronald Press’^ 1939 •
Stevens, W. Mackenzie, Financial Organlza11on and Administra­
tion. New York:
The American Book Company, 1934•
B.
Periodicals
"Accounting and the S.E.C."
No. 3. September, 1937*
The Accounting Review, Vol. 12,
"Accounting and the S.E.C."
No. 4. December, 1937*
The Accounting Review, Vol. 12,
"Accounting and the S.E.C."
No. 1. March, 1938.
The Accounting Review, Vol. 13,
Blough, Carman G., "The Relationship of the Securities and
Exchange Commission to the Accountants,"
Journal of
Accountancy, Vol. 63, No. 1. January 1937
Matthews, George C., "Accounting in the Regulation of Security
Sales," Accounting Review, Vol. 13, No. 3, September, 1938
Robinson, Leland Rex., "Are Present Forms of Financial State­
ments Satisfactory?"
J ournal of Accountancy, Vol. 62,
No. 6, December, 1936.
Werntz, William W . , "Some Problems as to Parent Companies,"
J ournal of Accountancy, Vol. 67, No. 6, June, 1939*
The following data made available by the Securities and Exchange
Commission
Acts, Rules and Regulations;
Securities Act of 1933 as amended.
Securities Exchange Act of 1934 and amendments.
Securities and Exchange Coihmiss'ion, General Rules and
Regulations under the Securities Exchange Act of 1934.
82
Form and Instruction Books:
Form A -2 for Corporations.
Instruction Book for Form A -2
Formal Decisions:
Securities and Exchange Commission, Decisions, Vol. 1,
J u l y 2, 1934 - December 31, 1936.
Washington, D.C.:
Government Printing Office, 1938.
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