Walking through the swamp: Understanding SEC filings Oct. 2, 2003 Chris Roush Assistant Professor School of Journalism and Mass Communication University

Walking through the Walking through the swamp: Understanding swamp: Understanding

SEC filingsSEC filingsOct. 2, 2003Oct. 2, 2003

Chris Roush

Assistant Professor

School of Journalism and Mass Communication

University of North Carolina at Chapel Hill

[email protected]

The Basics

Being a business reporter or editor is a lot like covering city hall, or the county commission. You spend a lot of time talking to sources and finding documents to support your story.

The problem: Most business journalists were not trained to do this work. They learned on the job and don’t know where to find the information needed to make their stories kick some serious butt.

What you need to know

The SEC is not a football conference for schools from South Carolina to Louisiana.

The SEC regulates all companies that have stocks or bonds that trade regularly. This includes all public companies and some private companies.

Because the SEC is there to protect investors, or shareholders, it requires lots of information to be filled for public dissemination. This is the treasure trove for business reporters.

How does it do that?

Simple. If the SEC requires companies to file information about their operations on a regular basis, then investors and potential investors will be able to read that information.

The bad information disclosed – most likely in an SEC filing and not in a news release – will likely send a stock price down. The good information will likely be disclosed with horns blaring and whistles blowing in a release.

The SEC and you

That’s why the good business journalist reads the SEC filings.

And that’s why the SEC is quite often the best friend of the business reporter.

Form 10-Q

Quarterly filing of a company’s financial statement, plus other GOOD STUFF.

Must be filed with the SEC within 45 days of the end of the quarter. That makes May 15, Aug. 14 and Nov. 14 busy reading days.

Companies that don’t file within this time frame typically are having problems.

Form 10-Q: The Good Stuff

Is the company buying its stock? This 10-Q disclosure is interesting because it tells investors whether or not the company believes the stock is undervalued, or overvalued.

If a company has been repurchasing a large amount of its stock in the recent quarter, then the CFO or CEO probably thinks it’s a good investment.

That’s information you want to tell your readers, because they will buy and sell stocks based on this information.


“The Company may repurchase as much as $120 million of its outstanding Class A common stock through December 31, 2002. During the second quarter of 2002, 25,500 shares were repurchased at a total cost of $734,295 or an average price of $28.80. The Company repurchased 149,957 shares at a total cost of $4,300,216 during the second quarter of 2001.”


What does this tell us? That whoever is in charge of this company’s stock buyback plan may have thought the stock was a lot cheaper a year ago, when they spent $4.3M in the second quarter, than in the most recent quarter, when they spent only $700K to buy back stock.

Companies buy stock when they think it’s cheap and going to go up, not when they think it’s expensive.


Sometimes companies plan to spend money in the future to improve their infrastructure or other operations.

It may involve building a new factory, or adding new computers.

Again, not all companies report this in their 10-Q filings, but when they do, they can estimate the financial impact to future earnings – something that an investor/reader will want to know.

If business journalists can write stories about this information, then we will have served our readers – who are shareholders -- well.


“In 2001, the Company began the development of several eCommerce initiatives in support of the Erie Insurance Group’s business model of distributing insurance products exclusively through independent agents. The eCommerce program includes initiatives to replace property/casualty policy administration systems as well as customer interaction systems. The eCommerce program also includes significant information technology infrastructure expenditures. The program is intended to improve service and efficiency, as well as result in increased sales. Total five-year expenditures for the program are estimated at $150 to $175 million. The cost of these initiatives will be shared among several companies of the Erie Insurance Group, including the Company. Based on preliminary estimates, which will be further refined in the second half of 2001, the after-tax effect on net income of the Company is estimated to reduce earnings per share between $0.08 and $0.12 for 2001 and between $0.05 and $0.07 per share for each of the next four years of the program.”


Business decisions, either made by by the company or by clients that could have an adverse affect on the company’s financial performance, are often disclosed in a 10-Q. Here’s a good example:

“In late July, the Company received notice from the Massachusetts Teachers Association (MTA) that the MTA is terminating its agency relationship with the Company and has withdrawn their endorsement, effective January 1, 2002, of the personal automobile group-marketing plan made available to members of the MTA by The Commerce Insurance Company. Commerce expects that approximately $16.7 million of premiums written will not be renewed as a result of this.”


Litigation is also discussed frequently in 10-Q filings. This can be quite nasty sometimes. But it can also affect stock prices, and companies will often set aside money to pay for settlements or adverse rulings resulting from lawsuits. They can be even juicier, and more important, to readers, if the litigation involves

litigation between two public companies.

Form 10-Q: the Good Stuff

Quite often, a company will disclose the sale price, or purchase price, of a recent deal in a 10-Q. Or it may use the 10-Q as a way to update the world on the progress of a recent acquisition. Business journalists are always interested in these nuggets of information, because the price likely hasn’t been disclosed elsewhere, or likely contain numbers that we haven’t seen before. That, my friends, is a story.


A recent filing from St. Paul Cos.: “In connection with the MMI purchase, we established a reserve of $28 million, including $4 million in employee-related costs and $24 million in occupancy-related costs. The employee-related costs represent severance and related benefits such as outplacement counseling to be paid to, or incurred on behalf of, terminated employees. We estimated that approximately 130 employee positions would be eliminated, at all levels throughout MMI. Through June 30, 2001, 118 employees had been terminated, with payments totaling $4 million. Our remaining obligations for employee-related costs at MMI are expected to be less than $1 million.”

A final word on The Good Stuff

This information is not always contained in the same place for every 10-Q.

The lawsuit information is commonly under a header called “Contingency.”

The information about rate increases and business decisions can sometimes be found under “Management’s Discussion,” but in some other 10-Qs is located in a footnote.

It pays to read the entire filing sometimes.

The 10-K

The mother of all filings with the SEC for a company. It is a more detailed version of a 10-Q that is filed once a

year. Companies have 90 days after the end of the fiscal year to file a 10-K. This makes the end of March a busy reading time for business journalists.

The biggest difference between a 10-Q and a 10-K is that the Q discusses financial performance for a quarter, while a K discusses financial performance for the entire year.

For that reason, the news you want to look for in a 10-K is similar to the news you want to look for in a 10-Q: Litigation, extra expenses, changes in operation, stock repurchases, etc.

DEF 14A: The Proxy Statement

Show me the money. This is where companies have to tell investors every year how much money they have paid their top executives.

This filing is sent to every investor of a company. There are proposals included in it that the company’s shareholders will vote on at its annual meeting.

But business journalists primarily care about salary and bonus disclosures, and sweetheart deals with board members.

The Proxy

LONG-TERM COMPENSATION ANNUAL COMPENSATION AWARDS NUMBER OF RESTRICTED SECURITIES UNDERLYING STOCK OPTIONS/SARS ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OTHER(1) AWARDS(2) (INSHARES)(3) COMPENSATION(4) Stephen C. Hilbert (5) 1999 $1,000,000 $7,895,391(6) $123,254 $1,192,369 2,047,443 $835,974 Chairman of the Board, 1998 1,000,000 13,500,000 130,714 1,275,891 2,571,897 754,568 President and Chief Executive Officer 1997 250,000 15,000,000 163,240 4,156,373 2,561,792 4,297 Ngaire E. Cuneo 1999 250,000 4,500,000 390,635 221,814 4,745 Executive Vice President, 1998 250,000 1,235,000 109,718 422,967 4,991 Corporate Development 1997 250,000 2,612,000 780,035 621,859 4,983 Rollin M. Dick (5) 1999 250,000 3,800,000 333,041 609,812 592,360 Executive Vice President 1998 250,000 3,816,000 302,094 741,635 554,510 and Chief Financial Officer 1997 250,000 3,816,000 1,108,184 853,452 20,669 Thomas J. Kilian (5) (7) 1999 250,000 2,000,000 185,023 5,447 3,570 Executive Vice President 1998 237,148 1,262,852 56,520 352,576 3,896 and Chief Operations Officer Maxwell E. Bublitz(7) 1999 250,000 1,800,000 168,576 5,447 3,227 Senior Vice President, 1998 250,000 1,400,000 28,558 201,785 3,608 Investments

The Proxy

Here is what should jump out at even the first-time proxy reader when looking at this chart:

Mr. Hilbert was making a ton of money. His “all other compensation” is more than three times the salary of his executive vice presidents. Look at the (4) footnote to find out why he is being paid this money. (In this case, it’s the amount of premiums for split-dollar life insurance that the company paid on behalf of Mr. Hilbert. But you also see items here such as companies buying the homes of executives, paying for cars and airplanes, or relocations.)

Although Hilbert’s bonus is still outrageous, it declines by almost half in 1999. Does the (6) footnote explain why? The footnote states: “Mr. Hilbert agreed that his bonus, after reduction for cash to pay taxes, relating to the last three quarters of 1999, was to be paid in shares of Common Stock valued at the higher of $50 per share or market. Consequently, his bonus for 1999 consisted of 108,221 shares of Common Stock (which are reflected in the table at the values at the respective dates of issuance) and $5,466,056 in cash.” You should look also elsewhere for more explanation. Where? I’ll get to that in a minute.

Why have the restricted stock awards gone down in the past three years? Again, you should look for an explanation for why this is happening.

The Proxy

In typical bassackwards fashion, the report on executive compensation is not usually found with the chart on executive compensation.

Instead, you’ll have to look for it elsewhere in the proxy. THERE IS NO UNIFORM PLACE FOR WHERE THIS IS PLACED IN THE PROXY. Some companies place it early on in the proxy with all of the other board of director-type stuff. Others place it way in the back, assuming that many proxy readers will fall asleep before they get to it.

But look for it. It is the report from the members of the board of directors who sit on the compensation committee, which decides how much or how little executives get paid.

The Proxy

For example, the Conseco compensation committee report tells you that: “In 1998 Conseco and Mr. Hilbert entered into a new employment agreement (the "CEO Contract"). The CEO Contract provided for an annual salary of $1 million. In addition, Mr. Hilbert was entitled to receive an annual bonus equal to the lesser of a non-discretionary amount ($13.5 million for 1999 prior to the revision described below) or 3 percent of Net Profits. Mr. Hilbert was entitled to receive an additional bonus for any year in excess of this amount only if payment of that additional bonus amount would not cause the total bonus to exceed 3 percent of the annual Net Profits and the Company's return on equity ("ROE") for such year after giving effect to such bonus would be at least 15 percent. In addition, the Compensation Committee had the authority under the CEO Contract to reduce any such additional bonus. The Company's ROE for 1999 was less than 15%. Consequently, Mr. Hilbert's bonus for 1999 would have been $13.5 million, but Mr. Hilbert agreed that his bonus, after reduction for cash to pay taxes, relating to the last three quarters of 1999, was to be paid in shares of Common Stock valued at the higher of $50 per share or market. Consequently his bonus for 1999 consisted of 108,221 shares of Common Stock and $5,466,056 in cash.”

Although this is a lot of legal mumbo jumbo, it does tell you why his bonus was reduced last year. And there is also an explanation in the compensation committee report as to why the stock options were reduced. This is where the story is for the business journalist.

Wait, it just gets better

Another eyebrow-raising section of the proxy that is normally contained right after the list of the members of the board of directors. It details business relationships between board members and the company.

For example, if a board member is an attorney, this section will detail, in $ amounts, how much the company is paying his or her law firm in annual fees.

Or if a board member owns a company that does business with the proxy company, this section will detail how much is being paid to that company on an annual basis in fees, etc.

These often make great stories for the business section.

Some egregious examples

“On April 23, 1999, the Company sold its corporate airplane, a Canadair Challenger 601-1A, to a company independently owned by Peter B. Lewis. The airplane was sold to Mr. Lewis for $12.1 million, the fair market value as determined by JetPerspectives, Inc., an independent aircraft appraiser. The net book value of the airplane was $6.9 million at the date of the sale. Operation of the airplane is supported by two pilots and a mechanic, who are employees of a subsidiary of the Company.” Lewis is the CEO and chairman of this company. Do you think this makes a story?

A subsidiary of the Company paid Richard Wolfson, a son-in-law of Mr. Abramson,$150,469 under an independent contractor agreement for services rendered in1999. Abramson is the chairman of the board of the company that filed this proxy. Is there a story here?

During 1999, the Company and its subsidiaries paid $7,068,958 to Criterion Communications, Inc. pursuant to a service agreement. Marcy Shoemaker (a daughter of Mr. Abramson) owns 100% of the outstanding voting securities of Criterion. Again, Abramson is the chairman of this company. Story?

Form 8-K

These are the filings with the SEC that keep public relations workers honest.

In legal lingo, an 8-K is a “current event report” for a “materially important” occurrence in the life of a public corporation. This means that an 8-K can disclose just about anything.

An event that requires disclosure is made under one or more of the following eight items: change in control, acquisition or disposition of assets, bankruptcy court filing, change in accounting firm, resignation of directors, financial statements and exhibits, and change in fiscal year.

An 8-K story

Dow Jones Business NewsDeloitte Resigns As Universal Insurance Holdings Auditor Tuesday October 8, 9:17 am ET WASHINGTON -(Dow Jones)- Deloitte & Touche LLP resigned as Universal Insurance Holdings Inc.'s auditor on Sept. 30, according to a Form 8-K filed late Monday with the Securities and Exchange Commission. The filing didn't state the reason for Deloitte & Touche's resignation. During 2001, Deloitte & Touche informed the company of a "material weakness" that existed in the design and operation of the company's internal control related to the processing of claims payments. There were no disagreements between Deloitte & Touche and Universal Insurance on any accounting matters for 2001 and through Sept. 30, the filing said. Universal Insurance is based in Aventura, Fla. -Marc A. Wojno, Dow Jones Newswires; 202-628-9792.

Form 8-K

The filing of an 8-K separates the wheat from the chaff. There used to be a saying at a newspaper I worked at: Regardless of what the public relations person might say, if the event doesn’t merit the filing of an 8-K, then it probably doesn’t merit being on page 1 of the business section.

Quite often, the 8-K filed by a company is simply a copy of the news release issued. However, sometimes the 8-K will contain extra information not provided in the release. And sometimes, the 8-K will be filed without a release being issued. Those are, quite often, the best for “news.”

Form 8-K

As a general rule of thumb, when a company files an 8-K, but doesn’t issue a release about the news in the filing, then general it’s information that the company must disclose, but doesn’t want to.

A lot of these are filed on Friday afternoon.

An 8-K beauty

“The California Department of Insurance ("CDI") has seized the assets and operations of and conserved Superior National Insurance Group Inc.'s (the "Company") four California domiciled insurance subsidiaries,California Compensation Insurance Company,Combined Benefits Insurance Company, Superior National Insurance Company,and Superior Pacific Casualty Company (the "Insurance Companies").Commercial Compensation Insurance Company, another subsidiary of the Company, will either be conserved in its state of domicile, New York, or will be redomiciled in California in order to become subject to the supervision of CDI.

“The Nasdaq National Market has halted trading in the Company's common stock since approximately 11:06 a.m. on Friday, March 3, 2000, pending the receipt of a response to a request for information delivered to the Company. The Company expects to provide the information requested no later than March 20, 2000, but has no assurance that trading will resume or that the Nasdaq will not take an adverse action with respect to the continued listing of the Company's common stock.

“The Company has retained bankruptcy counsel to advise it on possible alternatives, but has no present plans to seek the protection of the bankruptcy courts.

“Voice messages may be left for the Company's executives at 818/707-1464 until new corporate offices are established.”

Let me get this straight

This company has been a.) seized by regulators, b.) hired a bankruptcy attorney, c.) seen trading in its stock halted and d.) it doesn’t have any offices any more, but THEY’RE NOT PLANNING TO SEEK BANKRUPTCY PROTECTION?

Puhhlease.

Form S-1

A Form S-1 is filed with the SEC when a private company wants to sell stock on Wall Street and convert to a public company.

The filing is important to a business journalist because it gives us our first glimpse at a company that has previously been private and hasn’t disclosed to us any financial information or analysis of its performance.

We can find out how much money a private company has made, or lost, in the past.

What to look for in an S-1

Size and Scope: People reading a story about a company filing to sell shares to the public will want to know how many shares will be sold, and a range of the price of the stock.

The more shares a company sells, in general, the more interest the Wall Street brokers are having in getting their clients to buy the stock.

The stock price range is also important, because it can also be an indication of the demand for the offering.

The changes in the stock price range should be looked at in conjunction with the number of shares being offered. At the same time, a company raised the stock price range of its offering, it has also decreased the amount of shares in the IPO from 73.8 million to 48.8 million. They’ve upped the price, but lowered the amount of shares they’re going to sell. What we have here is a case of basic supply-and-demand economics. The fewer shares, the greater the demand from investors.


The listing of the underwriters will give you an indication of how successful the company could be in selling the stock. If you see big Wall Street firms like Goldman, Salomon, JP Morgan and Morgan Stanley listed as underwriters, that should be a sign that these firms will be selling as much of the offering to their institutional clients as possible. That increases the chances of the IPO rising shortly after the stock begins trading.

I think it’s important to note, however, relationships between the underwriters and the company going public detailed in the S-1 filing. Sometimes that tells a better story of why a Wall Street firm is an underwriter in the offering:

“Mr. Mario P. Torsiello, one of our directors, currently serves as a Managing Director of Dresdner Kleinwort Wasserstein, Inc., an affiliate of which, Dresdner Kleinwort Wasserstein Securities LLC, is acting as an underwriter in this offering.”


The risk factors section in an S-1 is where every company going public has to list anything and everything that could possibly go wrong that would result in its stock price going down. Dirty laundry and skeletons in the closet are disclosed here.

Some risk factors are basic and are included in virtually every S-1. They talk about how a downturn in the overall market may hurt a company. They will also mention competition.

What you want to look for are risk factors unique to the company. A recent S-1 noted a company’s high debt levels, which may limit its ability

to finance growth and make acquisitions. “Our debt level reduces our flexibility in responding to changing business and economic conditions, including increased competition in the insurance brokerage industry,” its filing stated. “And our debt level limits our ability to pursue other business opportunities, borrow more money for operations or capital in the future and implement our business strategies.”


Business reporters also want to tell their readers whether a company is selling stock above or below the company’s actual worth. To do this, you need to look for the disclosure of the company’s net tangible value.

Why is this important? Investors or other people who may be interested in buying stock in this company may be turned off if the company plans to sell the stock at $20.00 per share, but the company’s net tangible value is only $16.00 per share.

In other words, investors who bought the IPO stock are doing so at a price much higher than the actual worth of the company. They’re doing so under the belief that the company’s worth will go up in the future.

Final tips on S-1s

Form S-1s are often amended. You should always read the amended filings to find what has been changed.

Review the financial performance of the company. Dramatic shifts from losing money to making money should be noted in your story, as should dramatic changes in the opposite direction.

Most S-1s include the first disclosures about executive compensation, stock options, loans to corporate executives, and other juicy tidbits. If you are reporting on an S-1, it’s important to read the document the entire way through. Some information that you think might be included in one section may not be there, but could be elsewhere.

Form S-4

A Form S-4 is filed when a company wants to sell more shares of its stock and needs shareholder approval to do so. Why does a company want to sell more stock? The most common reason is that it wants to make an acquisition.

Form S-4s also have nice background details on how deals were negotiated: Phone conversations, lower bids that were then raised, bidders who dropped out, etc.

These filings make great business stories, because they’re often overlooked as places to find information.

Insider Trading

It’s not illegal, if done right. But is it done right? Form 4, Schedule 13D and the Schedule 13G are the

forms to look at to see insider trading. According to the rules used by the SEC to govern

investing, an insider is defined as an officer or director of a public company or an individual or entity owning 10% of more of any class of a company’s shares.

Insider Trading

Executives and board members can buy and sell stock in their companies as long as they file a Form 4 with the SEC following the transaction. If an insider buys or sells stock in the open market, he or she must file with the SEC by the 10th day of the month following such a trade.

It becomes illegal insider trading when the executive, director or outside investor buys or sells stock in the company based on non-public information that is, or could be, considered material in nature – generally anything that would require the company to file a Form 8-K.

Insider Trading

Schedule 13 filings indicate the activity of outside investors in a particular stock. An increase or decrease in Schedule 13 filings can be an indicator of what the Wall Street pros think about a certain stock.

The SEC notes that “certain institutional investors and professionals in the securities business … often acquire securities in the ordinary course of their business and not with a view toward changing or effecting change in the control of an issuer.” When this happens, an institutional investor files a 13G.

How much of a treasure trove of information is this? Schedule 13Gs and Schedule 13Ds give names and phone numbers to investors buying and selling stocks in companies.

Insider Trading

The difference between 13Ds and 13Gs is that the 13D indicates the initial investment by a shareholder or group of shareholders -- that they have purchased 5% or more of a company’s shares. The 13D must be filed within 10 days of the investment. In addition, someone filing a 13D typically wants a change at the company. These are most often disgruntled shareholders.

A 13G, on the other hand, must be filed within 10 days of the end of the quarter when the transaction occurred.

A 14D is associated with a hostile takeover. Be on the lookout for these too.

Regulation FD

This is not a form that has to be filed with the SEC, but it’s still important to business reporting.

Regulation FD stands for Fair Disclosure, and it requires companies to disseminate information to all investors at the same time.

What this means is that when companies hold conference calls or other meetings with investors, they are required to open it up to anyone. This means everyone from my grandmother in Thomasville, Ga., to business reporters.

Documents

Walking through the swamp: Understanding SEC filings Oct. 2, 2003 Chris Roush Assistant Professor School of Journalism and Mass Communication University