Lesson 8 of 9
What a filing says about itself
The strongest accounting-quality signal in a filing is the one the filing makes about its own reliability, and checking it takes about four minutes.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Two sign-offs answer different questions: one covers the report itself, the other whether internal control over financial reporting was effective.
- An unqualified opinion on the statements beside an adverse opinion on internal control means the numbers are right and the process that produced them is not.
- A material weakness must be disclosed. A less severe significant deficiency does not have to be.
The strongest accounting-quality signal a filing produces is not a ratio. It is a statement the filing makes about its own reliability, in plain English, in the same document as the numbers, and almost nobody looks for it.
What two opinions together can mean
RowsThe statementsColumnsInternal control opinion
Clean opinion, not restated, Adverse
The numbers, not the process
Clean opinion, not restated, Effective
The ordinary case
Restated later (8-K Item 4.02), Adverse
Both in question
Restated later (8-K Item 4.02), Effective
Controls passed, figures withdrawn
Two sign-offs, two questions
Section 302 of the Sarbanes-Oxley Act of 2002 produces certifications the chief executive and the chief financial officer sign with every annual and quarterly report. They cover the report itself and the disclosure controls behind it.
Section 404 produces something different: management's own assessment of whether internal control over financial reporting was effective, and for an accelerated filer, the auditor's separate attestation on the same question. An accelerated filer's 10-K therefore carries two opinions, not one, and they can disagree.
Only one failure reaches you
A control failure gets classified, and the classification decides whether a reader ever hears about it. A significant deficiency is judged less severe and goes to the audit committee without becoming public. A material weakness is judged severe enough that there is a reasonable possibility a material misstatement will not be prevented or caught in time. It must be disclosed.
The same underlying problem can be classified either way by two competent people, so the difference between a filing that discloses one and a filing that does not is partly severity and partly judgement. A Form 8-K under Item 4.02, a restatement announcement, needs no such judgement: the company is telling you that numbers you may have used were wrong.
The check that needs no accounting
The interval between fiscal year end and filing date needs no accounting at all. A 10-K is due within 60 days for a large accelerated filer, 75 days for an accelerated filer and 90 days for everyone else. The deadline matters less than the filer's own pattern against it. A company that filed comfortably inside its window for five years and then files at the edge of it has told you something, and it cost nothing to find.
Do it on a real 10-K, in four minutes
- Search the 10-K for the words material weakness.
- Read management's report on internal control and the auditor's, and check the two conclusions agree.
- On EDGAR, list three years of 8-K filings and look for Item 4.01, a change of auditor, and Item 4.02.
- Note the days between fiscal year end and filing date for the last three annual reports.
Check yourself
An accelerated filer's 10-K carries an unqualified opinion on the financial statements and an adverse opinion on internal control. What does that combination mean?
- The numbers are wrong
- The auditor believes the numbers are right and the process that produced them is not reliable
- The company is not a real filer
Show the answer
Answer: B.
The two opinions answer different questions. This combination says the numbers passed this year and the process behind them did not.Which control failure must be disclosed in the annual report?
- A significant deficiency
- A material weakness
- Neither is ever disclosed
Show the answer
Answer: B.
A significant deficiency goes to the audit committee without becoming public. A material weakness must be disclosed, which is why it is the one you can see.A large accelerated filer has filed its 10-K comfortably early for five straight years, then files on day 59 of its 60-day window this year. What does that suggest?
- Nothing, since day 59 is still within the deadline
- Something changed, and it is worth a closer look
- The company missed its deadline
Show the answer
Answer: B.
The deadline was met, but the filer's own pattern moved from comfortable to the edge of the window, a fact that needed no accounting to notice.Sources
- Sections 302 and 404 of the Sarbanes-Oxley Act of 2002: the certifications and the assessment of internal control over financial reporting.
- Form 8-K, Item 4.02: a determination that previously issued financial statements should no longer be relied upon.
- Form 10-K, General Instruction A(2): the 60, 75 and 90 day filing deadlines by filer category.
What this leaves out
- A disclosed material weakness is a statement about internal control on a date. It is not a statement that any reported figure is wrong.
- Non-accelerated filers carry no auditor attestation on internal control, so its absence is a fact about filer size, not about control quality.
- A significant deficiency does not have to be disclosed publicly, so the absence of a disclosed material weakness is not evidence that no problem exists.
- Nothing here is advice about any security.