ABACUS COAL EXPLORATION AND DEVELOPMENT CORPORATION, PETITIONER, VS. SECURITIES AND EXCHANGE COMMISSION, RESPONDENT.

Abacus Coal Exploration and Development Corporation versus Securities and Exchange Commission

The Case

This is a petition for review on certiorari brought by Abacus Coal Exploration and Development Corporation against the Securities and Exchange Commission. Abacus Coal asks the Supreme Court to overturn the finding that its audited financial statements for 2008 and 2009 contained material deficiencies and material misstatements, and to set aside the fines imposed for those defects. The case matters because it fixes, in plain and enforceable terms, what the securities law demands of a corporation's balance sheet: that intangible assets and issued capital appear on the face of the statement itself, not buried in the notes, and that a company cannot plead good faith when the very information it omitted was already in its hands.

Procedural History

The Company Registration and Monitoring Division of the Securities and Exchange Commission issued a letter-order directing Abacus Coal to pay a fine of 590,000 pesos for the material misstatements in its 2008 and 2009 financial statements. Abacus Coal appealed to the Securities and Exchange Commission En Banc. While that appeal was pending, it filed revised financial statements for both years. The Commission En Banc denied the appeal but modified the penalty, ordering a fine of one million pesos per year of misstatement, or two million pesos in all, and directing Abacus Coal to correct its statements to reflect the misstatements of asset and equity amounting to 2.7 billion pesos. Abacus Coal then went up to the Court of Appeals by petition for review under Rule 43. The Court of Appeals denied the petition and affirmed the Commission En Banc in full; it likewise denied reconsideration. Abacus Coal then filed with the Supreme Court this petition for review on certiorari under Rule 45.

Facts

Abacus Coal is a domestic corporation engaged in the commercial exploration and development of coal, and is a wholly owned subsidiary of Abacus Consolidated Resources and Holdings, Incorporated. On September 23, 2008, the parent corporation executed a deed of assignment transferring its coal mining rights under Coal Operating Contract Number 148 to Abacus Coal. Those rights were valued at 2,693,403,665 pesos, or roughly 2.7 billion pesos, and in exchange the parent was to receive 29.5 billion shares of Abacus Coal at a par value of one centavo per share.

On December 24, 2008, the Securities and Exchange Commission approved Abacus Coal's application to increase its authorized capital stock from 20 million pesos to 300 million pesos. The 295 million pesos worth of shares was fully subscribed and paid for by the parent through the assignment of the mining rights. Yet in the audited financial statements it filed for 2008 and 2009, Abacus Coal did not record the increase in capital stock on its balance sheet to reflect the acquisition of the mining rights. The matter appeared only in the notes to those statements.

The Commission's registration division summoned Abacus Coal to show cause why it should not be penalized. Abacus Coal insisted there was no misstatement, blaming a conflict between accounting standards and the approval of its capital increase, and pointing out that the increase was disclosed in the share capital portion and the deferred coal exploration costs. The division was not persuaded and imposed the fine. The revised statements Abacus Coal later filed still did not report the appraised value of the mining rights at 2.7 billion pesos.

Issues

• Whether or not the Court of Appeals gravely erred in affirming the finding that Abacus Coal committed material deficiencies and material misstatements in its 2008 and 2009 audited financial statements.
• Whether or not Abacus Coal's disclosures in the notes to its financial statements, and its subsequent revised statements, may excuse it on a claim of good faith.
• Whether or not the penalty of two million pesos imposed by the Commission En Banc is correct.

Applicable Provisions

Rule 68 of the Securities Regulation Code, on the minimum presentation of the balance sheet, provides:

As a minimum, the face of the balance sheet should include the following line items: 1) Cash and Cash Equivalents; 2) Financial Assets (excluding amounts shown under (1), (3), and (6); 3) Trade and Other Receivables; 4) Inventories; 5) Property Plant and Equipment; 6) Investments accounted for using the equity method; 7) Intangible Assets; 8) Trade and other payables; 9) Tax Liabilities and assets as required by SFAS No. 23, Accounting for Income Taxes; 10) Provisions; 11) Non-current interest-bearing liabilities; 12) Minority interest; and 13) Issued capital and reserves.

This is the provision that dooms Abacus Coal, because the mining rights are intangible assets and the shares issued are issued capital, both of which the rule requires on the face of the balance sheet.

Securities and Exchange Commission Memorandum Circular Number 8, series of 2009, on the test of materiality, provides:

The required disclosures or presentations under the applicable financial reporting framework and SRC Rule 68/68.1 for a significant account are not provided in the financial statements.

This defines the material deficiency committed when required disclosures for a significant account are missing from the statements.

The same circular, on material misstatement, provides:

Such other misstatements in the financial statement, i.e., overstatement or understatement of income, asset, liability or equity, that the Commission may consider material.

This supplies the basis for treating the understatement of Abacus Coal's assets and equity as a material misstatement.

Ruling

On the first issue, the Court held that the petition is without merit. It noted that Abacus Coal merely repeated the arguments already passed upon by the Court of Appeals and raised questions of fact, which are generally outside the scope of a Rule 45 petition, and that no recognized exception applied. On the merits, the Court agreed that the failure to disclose the mining rights as assets, and the corresponding additional capital, constituted both material deficiencies and material misstatements. The rules are unequivocal, and the information belonged on the balance sheet, not in the notes.

On the second issue, the Court rejected the claim of good faith. The notes merely describe the items and values in the financial statements. Note 5 spoke only of deferred coal exploration costs of 6,681,872 pesos and never declared the mining rights as an asset valued at 2.7 billion pesos; Note 7 disclosed the increase in authorized capital but not the shares issued to the parent nor the values behind that issuance. The Court stressed that the information was readily available, since the Commission had approved the capital increase as early as December 24, 2008. The revised statements did not cure the defect, because they still omitted the appraised value of 2.7 billion pesos. The omissions were material precisely because of their potential impact on the investing public.

On the third issue, the Court upheld the penalty. The fine is based on one tenth of one percent of the amount of the misstatement, subject to the statutory cap, and since one tenth of one percent of 2.7 billion pesos exceeds the cap, the total imposable fine is two million pesos, or one million pesos per year of misstatement. The Court also deferred to the factual findings of the Commission as an administrative body with expertise, supported as they were by substantial evidence.

Doctrine

First, under Rule 68 of the Securities Regulation Code, intangible assets and issued capital and reserves must appear as line items on the face of the balance sheet; disclosure in the notes to the financial statements does not satisfy the rule, because the notes merely describe the items and values already in the statements.

Second, the omission of such required disclosures for a significant account is a material deficiency, and the resulting understatement of assets or equity is a material misstatement, as defined in Securities and Exchange Commission Memorandum Circular Number 8, series of 2009.

Third, good faith is unavailable where the omitted information was readily available to the corporation, as when the Commission had already approved the capital increase before the statements were issued.

Fourth, materiality is measured by whether the omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.

Fifth, the factual findings of the Securities and Exchange Commission, as an administrative body with expertise, are accorded respect and finality when supported by substantial evidence.

Disposition

The petition was denied, and the decision and resolution of the Court of Appeals were affirmed; Abacus Coal lost and must pay the two million peso fine and correct its financial statements.

Remember This

Memorize this line: intangible assets and issued capital must be on the face of the balance sheet, and notes to the financial statements will not save a corporation from a charge of material misstatement. Examiners use this case in corporation law and securities regulation to test the materiality standard, the limits of good faith in financial reporting, and the deference owed to the Securities and Exchange Commission's factual findings.