Those tasked with filing their company’s financial statements with the Securities and Exchange Commission have some helpful tips and best practices for responding to staff requests and comments, courtesy of a Division of Corporation Finance staff member.
At a recent SEC conference sponsored by the New York State Society of CPAs, Steven Jacobs, associate chief accountant in the SEC’s Division of Corporation Finance, gave an update on recent Corp Fin developments, including some pointers for dealing with the staff and some of the disclosure issues companies should pay attention to in their filings.
Jacobs advised issuers not to rush to restate simply because they got a comment from the staff seeking an explanation of their accounting. “The majority of the time, the first comment you’ll get from the staff will say, ‘Please tell us’, or `please explain,’” Jacobs said at the Sept. 17 event. “Very rarely will you see us ask you to amend your filing right off the bat. A lot of times the disclosure is just not sufficient enough for us to understand what your accounting is.”
Rather than jumping to restate, he said issuers should take advantage of the opportunity to explain their accounting in “sufficient detail.” In doing so, he warned companies not to “just give a quick response saying, ‘Our accounting is right because of X.’”
“You’ll probably get the same comment issued again and it may raise a lot of suspicion,” he noted. Instead, he advised companies to key their responses to the staff’s initial comment, to provide sufficient detail, and to discuss the supporting authoritative literature upon which they’re relying.
Pointing to the specific U.S. Generally Accepted Accounting Principles that address their accounting will put companies in the best position for dealing with the staff, said Jacobs.
“The staff would rather get a more thorough complete response that’s been through an appropriate level of review than get it back within ten days.”
—Steven Jacobs,
Associate Chief Accountant,
SEC Division of Corporation Finance
In cases where the staff doesn’t ask a company to amend its filing, but asks the issuer to provide disclosure in future filings, Jacobs said it’s good practice to “not only acknowledge that you’ll do it, but also to provide the draft disclosure or a template of what that might look like.” That way, he said, the company can ensure the staff is comfortable with the disclosure, rather than waiting until their next filing is reviewed.
He also urged companies not to be shy about reaching out to the staff, particularly if they don’t understand a request or comment, or if they’re unable to respond to a comment by the requested date. “The staff would rather get a more thorough complete response that’s been through an appropriate level of review than get it back within ten days,” he said.
Above all, Jacobs advised companies to document their accounting decisions contemporaneously so they can provide that documentation to the staff if a question arises. “That will make going through the process so much easier … and will have the least interruption on conducting your business,” he said.
MD&A Best Practices
Jacobs also offered some best practices for companies to keep in mind when drafting their Management Discussion & Analysis.
Among other things, he recommended that issuers consider including an executive-level overview that addresses what’s going on with their business and how the economic environment is affecting their business “so readers understand what they’re seeing in the financial statements from a big-picture standpoint and what’s causing those changes.”
REVIEWING THE REVIEW
The following excerpt from the SEC Division of Corporation Finance explains its “Filing Review Process.”
Required and Selective Review
As required by the Sarbanes-Oxley Act of 2002, the Division undertakes some level of review of each reporting company at least once every three years and reviews a significant number of companies more frequently. In addition, the Division selectively reviews transactional filings—documents companies file when they engage in public offerings, business combination transactions, and proxy solicitations.
In deciding how to allocate staff resources among filings, the Division undertakes a substantive evaluation of each company’s disclosure in what it calls a preliminary review. To preserve the integrity of the selective review process, the Division does not publicly disclose its preliminary review criteria. Based on its preliminary review, the Division decides whether to undertake any further review of the company’s filings or whether the company’s disclosure appears to be substantially in compliance with the applicable accounting principles and the federal securities laws and regulations.
Levels of Review
If the Division selects a filing for further review, the extent of that further review will depend on many factors, including the results of the preliminary review. The level of further review may be:
a full cover-to-cover review in which the staff will examine the entire filing for compliance with the applicable requirements of the federal securities laws and regulations;
a financial statement review in which the staff will examine the financial statements and related disclosure, such as Management’s Discussion and Analysis of Financial Condition and Results of Operations, for compliance with the applicable accounting standards and the disclosure requirements of the federal securities laws and regulations; or
a targeted issue review in which the staff will examine the filing for one or more specific items of disclosure for compliance with the applicable accounting standards and/or the disclosure requirements of the federal securities laws and regulations.
Much of the Division’s review involves reviewing the disclosure from a potential investor’s perspective and asking questions that an investor might ask when reading the document. When the staff notes instances where it believes a company can enhance its disclosure or improve its compliance with the applicable disclosure requirements, it provides the company with comments. The range of possible comments is broad and depends on the issues that arise in a particular filing review. The staff completes many filing reviews without issuing any comments.
In addition to a first level examiner, in nearly all cases a second person reviews a filing and proposed comments to help achieve consistency in comments across filing reviews. We refer to this person as the reviewer.
Source
Corporation Finance Filing Review Process (January 2009).
Companies should also discuss their critical accounting estimates in more granular detail, “not just repeating what’s in your significant accounting policies, but talking about the significant judgments made by management that have a material impact on the financial statements,” he said.
He also urged companies in their liquidity discussions to provide more details on changes in their operating cash flows, rather than just “taking the face of their cash flows statement and explaining the changes in individual line items.”
Another area of staff focus is companies’ disclosure of material weaknesses in the management assessment of Internal Control Over Financial Reporting as required under Sarbanes-Oxley Section 404(a). “Companies are not doing a good enough job of explaining what the deficiency is,” said Jacobs. “They’re taking too narrow of an approach.”
For instance, he noted that simply disclosing an audit adjustment related to income taxes doesn’t explain what the deficiency is, whether it’s a review control or an oversight control, or whether the control deficiency could impact any other areas of the financial statement.
The disclosure should be focused not just on where the issue is, but what the actual deficiency is, how pervasive it is, and the magnitude of the impact it can have, he said.
He noted that companies also need to think about remediation, not only in the period in which they report the weakness, but also in their ongoing 10-Qs, since there’s a requirement for companies to disclose changes in ICFR.
Jacobs also cited “a lot of confusion,” particularly among smaller companies, regarding the disclosure on ICFR versus the requirement to report on Disclosure Controls and Procedures under Item 307, which are separate evaluations.
“To the extent that you conclude that ICFR is ineffective and DCP is effective, we’ll usually expect some kind of explanation on how you reached that conclusion, considering most of ICFR is subsumed in DCP,” he said.
And in the event of a disagreement between a company and its independent auditor about the effectiveness of ICFR, Jacobs noted, “That would be helped by some robust disclosure by the company as well.”
For more on the SEC’s filing review process and other related resources, see the box at top right.
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