When the staff of the Securities and Exchange Commission publishes its views on some financial reporting topic, public companies and auditors typically flock to those comments and pore over every word, looking for any guidance they might offer to help the companies’ own financial reporting and auditing.
Those comment letters, dutifully published in the SEC’s EDGAR database, now number in the tens of thousands and have evolved into a treasure trove of guidance. According to Mark Cheffers, chief executive of Audit Analytics, as many as 60,000 letters written by SEC staff to public companies now sit on the SEC Web site, available to all.
Cheffers
“This has tremendous value,” he says. “The questions oftentimes are very precise, so you get a very precise discussion about the issue. It is a data set that will prove to be increasingly more valuable over time.”
Audit Analytics and Deloitte & Touche each have undertaken efforts to study the growing volume of comment letters and summarize the guidance they contain. The research has left Cheffers wondering about the extent to which an SEC comment letter can give rise to a restatement, a CFO departure, or a change in auditors.
Cheffers says his research didn’t establish a cause-and-effect relationship, but he noticed a correlation between SEC comment letters and restatements. For example, in 2006, 24 percent of registrants who received an SEC comment letter filed restatements soon afterward; 26 percent lost their CFO, and 16 percent lost their auditor.
“I don’t know if I’d call it a strong correlation, but it makes some sense,” he says. “If the SEC finds an area in a particular company or industry they’re concerned about, they’ll look at other companies in the same industry and have the same questions.”
Davine
Christine Davine, partner in charge of SEC services for Deloitte & Touche, says Deloitte’s review of comment letters has found plenty of evidence the SEC staff is still concerned with a lot of “old standby” issues, including revenue recognition, business combinations, and segment reporting and classifications. But there’s also growing interest at the SEC in emerging topics, she says, such as uncertain tax positions, fair value measurements, and disclosures pertinent to the current turbulence in debt and equity markets.
“SEC comment letters are becoming quite routine,” Davine says. “Reviewing the letters will help identify ways to improve the transparency of disclosures. You can look at comment letters both inside and outside a particular industry to help identify disclosure best practices and see what the SEC is focusing on.”
Cheffers says 27 percent of SEC comment letters focused on revenue recognition. According to Deloitte’s analysis, the SEC staff has focused much of that attention on multiple-element arrangements—for example, where a product sale might include service elements or other deliverables.
The staff often asks for additional information such as the nature of the elements involved, the accounting policy for each element, the company’s method for determining whether certain deliverables in an arrangement qualify as separate units of accounting, the company’s support for its conclusion that a delivered item has stand-alone value, and the timing of revenue recognition for each element in the arrangement.
“You can look at comment letters both inside and outside a particular industry to help identify disclosure best practices and see what the SEC is focusing on.”
— Christine Davine,
Partner in Charge of SEC Services,
Deloitte & Touche
Reflecting more recent market events, the SEC staff has issued numerous comments asking for more disclosures about valuation methods and assumptions, according to Deloitte’s analysis. As the credit crisis has become more acute, the SEC staff has focused more on a company’s ability to accurately portray its financial condition.
Cheffers says he was struck not only by the sheer number of letters that’s developed, but also by the broad range of filings they covered and issues they addressed. While before Sarbanes-Oxley the SEC staff was seen as focusing much of its attention on initial public offerings, today the attention is spread broadly across various industries and across filings such as 10-Ks, 10-Qs, 8-Ks, and registration and proxy statements. He estimates 20 percent of SEC comment letters focus on internal controls.
Delfini
Lisa Delfini, a partner with Deloitte’s SEC services group, says her study of SEC comment letters left her convinced that the staff review process is based on a genuine investor perspective. “They really do have the investor focus in mind,” she says. “Going through the comment can help companies to also have their own investors in mind.”
Deloitte also made a separate evaluation of SEC comments on filings that included accounting under International Financial Reporting Standards. D.J. Gannon, leader of Deloitte’s IFRS Center of Excellence for the Americas, says the SEC’s comments on IFRS disclosures seem more focused on education than on enforcement.
“This is relatively new for most companies and auditors,” he says. “IFRS is more objective, more principled, so the SEC staff is spending a lot of time trying to understand how companies have applied the standards. It’s more ‘explain how you did this’ than ‘we disagree with what you did.’ The vast majority of comments are just trying to understand what a company did.”
Gannon
Gannon says comments on IFRS filings seem to reflect an acceptance on the SEC’s part for use of judgment, an issue that has been a big concern to preparers who fear second-guessing when encouraged to use more professional judgment in applying principles-based standards. “Certainly there’s a degree of tolerance,” he says. “There’s a willingness there to try to understand what companies have done.”
Cheffers says while the number and direction of comment letters can be instructive, their ability to be instructive is somewhat limited by technology. There’s no meaningful way to quickly search or find letters that focus, for example, on companies of a particular size or in a particular industry. Searching by accounting or financial reporting topics is limited as well. He’s working on establishing a more useful method of searching and sorting letters.
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