Managing Legal Risk the Financial Reporting Process (Portfolio 5503)

  • This Portfolio discusses the legal risks public companies face in the financial reporting process and offers some advice for how to manage such risk.


Bloomberg Tax Portfolio 5503-3rd, Managing Legal Risk in the Financial Reporting Process (Accounting Policy and Practice Series), discusses the legal risks public companies face in the financial reporting process and offers information and suggestions for how to manage such risk.

Financial reporting by public companies is one of the foundations of the free enterprise system. Modern capitalism is built upon the financing of large entities by investors. Investors demand accountability for the capital they provide. The financial reporting process is the means by which public companies provide that accountability. Having a reputation for sound financial reporting will likely instill investor confidence in a company and enhance its ability to raise capital and use its securities to make acquisitions. Conversely, improper financial reporting will likely diminish investor confidence and lead to government investigations, shareholder litigation, and the costly measures needed to resolve these problems.

Written primarily for the benefit of the executive management and directors of public companies, this Portfolio analyzes the financial reporting process. It identifies risk factors in the financial reporting process and explains how those risk factors can increase the likelihood of violations of law. These include certain high-risk areas in the financial reporting process, where companies should be especially careful in their accounting and disclosures. To illustrate the problems that can occur, the Portfolio presents actual cases. The Portfolio also discusses the importance of establishing a record of good faith effort to comply with the financial reporting rules in order to lessen the potential for fraud and criminal charges, the most serious charges that a company may confront. It provides insight into the perspectives of the SEC and its staff on the financial reporting process. Moreover, the Portfolio calls attention to (a) the problem of one company assisting another company to violate financial reporting requirements, (b) the increased enforcement of the prohibitions against bribery of foreign government officials and other provisions of the Foreign Corrupt Practices Act, and (c) cybersecurity, all of which are areas of intensified focus for regulators at the beginning of the 21st century. Finally, the Portfolio suggests various steps that a company may take to reduce its legal risks, strengthen its financial reporting processes, and build a record of a good faith effort to comply with the financial reporting rules.

Securities law attorneys will appreciate that this Portfolio covers an enormous range of topics within the body of the federal securities laws and should understand that the citations of cases and other authorities herein are illustrative, not comprehensive. This Portfolio is intended first and foremost to be a practical aide to the management and directors of public companies, and not a traditional legal treatise. In the interest of making the issues discussed herein accessible to nonlawyers, this Portfolio is written in the vernacular, and gives preference to comprehensibility for the layperson over technical legal precision. A reader seeking a more detailed and technical discussion of relevant issues should refer to Bloomberg Tax Accounting Policy and Practice Series Portfolios concerning particular bodies of law or accounting rules.

This Portfolio should be cited as Bloomberg Tax Portfolio 5503-3rd, Wang, Managing Legal Risk in the Financial Reporting Process (Accounting Policy and Practice Series). Within the Accounting Policy and Practice Series, however, references to the Portfolios will include only the Portfolio numbers and titles.

Table of Contents

I. Introduction and Scope of Portfolio
II. History, Purpose, and Components of MD& A
III. Forward-Looking Information
IV. Significant Judicial and Administrative Action Involving MD& A
V. Recent Years’ Guidance on MD& A Disclosure in 2001 and Beyond
VI. Organization and Relationship to Part 1
VII. Introduction or Overview Section of MD& A
VIII. Liquidity and Capital Resources
IX. Results of Operations
X. Key Indicators of Financial Condition and Operating Performance
XI. Known Trends and Uncertainties
XII. Forward Looking Information
XIII. Safe Harbors – Meaningful Cautionary Language
XIV. Material Changes in Financial Statement Line Items
XV. Interim Period Reporting
XVI. Segment Analysis
XVII. Critical Accounting Estimates
XVIII. Off-Balance Sheet Arrangements and Tabular Disclosure of Contractual Obligations

Leonard Wang
Former Assistant Director
Division of Enforcement, SEC
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