Those awkward conversations you have with the Securities and Exchange Commission when staff comment on the logic in your periodic filings? They’re getting fewer and farther between.
The number of comment letter “conversations” raised by SEC staff in the Division of Corporation Finance has fallen 50 percent in the last five years, according to data provided by Audit Analytics. The total number of comment letters spiked to nearly 3,300 in 2009, but across the nine years of 2006-2014, conversations initiated by the SEC fell 36 percent. (See Table 1 in the sidebar at right.)
A more conservative (and potentially more accurate) measure of the decline in comment letters is that 27 percent of SEC registrants received comment letters for fiscal year 2005, compared to 22 percent in fiscal year 2013—a 5 percent reduction over the nine-year period. (See Table 2.)
Other measures showing improved efficiency in the comment letter process include a 53 percent decrease in the length of time to resolve issues raised by the SEC (from 105 days in 2006, to 48 days in 2014), and a 9 percent drop in the number of individual back-and-forth letters necessary (from the SEC and registrant) to resolve the issues raised in the first comment letter.
SEC comment letters have always been a rather delicate matter for financial reporting executives. Sometimes registrants aren’t sure a question from the SEC isn’t a question, as much as a hint that you should revisit your thinking; other times registrants reply to a comment letter and then don’t hear back for weeks (or longer), and wonder when a final resolution might ever arrive.
So what gives? Is financial reporting getting easier? Are corporate accountants and SEC staff getting smarter? Or is the comment letter process getting better?
“Those are all possible, if what you see is all there is,” says Jack Ciesielski, owner of R.G. Associates and a long-time observer of the corporate accounting scene. Ciesielski, however, does not believe simpler accounting explains the trend.
Five years ago, when comment letters topped out at 3,297, “we were still in the aftermath of the financial crisis; things were much more tenuous, and reporting was a lot more focused on what’s going into fair-value estimates,” Ciesielski says. “There now seems to be a relaxation of fear in what’s in some of the financial companies’ financial statements.”
He adds that the Financial Accounting Standards Board’s push for simpler accounting has largely happened only recently, and mainly on the private company side. Even the goodwill simplification extended to public companies hasn’t been met with as much enthusiasm as one might expect, he says, given the documentation requirements.
Ciesielski has scanned only a few comment letter conversations himself, mostly about untaxed foreign earnings, “and I think [SEC staff] are doing a pretty good job on targeting inconsistencies in disclosures.”
OK, if financial reporting rules aren’t yet getting simpler—are companies getting better at financial reporting itself?
“I would like to think that’s the case,” says Steve Jacobs, a partner at EY and former associate chief accountant at the Division of Corporation Finance. “Obviously internal controls have gotten better at companies, and that certainly impacts financial reporting and public company disclosure.”
“The transparency around the comment process has made it a lot easier to comply, as you can now anticipate a lot of the comments that the staff might raise.”
Dave Lynn, Partner, Morrison and Foerster
Another factor, Jacobs says, might be the increased frequency of large companies being reviewed. As a practical matter, most large companies are reviewed annually; that builds familiarity at Corp Fin and a heightened comfort level on both sides in dealing with the comment letter process.
Jacobs credits Corp Fin staff with starting consultations with other internal SEC staff earlier in the process. That reduces the number of back-and-forth letters and cuts the time necessary to resolve questions. “You are getting all the best thinking, so the staff are asking more precise questions earlier in the process and coming to conclusions more quickly,” he says.
Plus, he says, the conversation between companies and SEC staff is simply more open; registrants have even found it better to pick up the phone and call Corp Fin rather than exchange written correspondence. “I think it’s in everyone’s interest to resolve the process more quickly,” he says.
The SEC has also shifted a greater proportion of its reviews from smaller companies to larger companies, consistent with a risk-based approach. Jacobs believes this has shortened the time to resolve issues, since larger companies tend to have more resources and expertise. The result: while the percentage of registrants who receive comment letters is falling, the percent of all filings reviewed by Corp Fin has been rising.
NINE-YEAR TRENDS IN COMMENT LETTERS
The two tables below from Audit Analytics provide statistics on SEC Division of Corporate Finance Comment Letters on Form 10-K and Form 10-Q Filings.
Table 1: Volume of Letters, Length of Time to Resolve
Table 2: Comment Letter Conversations Initiated by SEC, as Percent of Audit Opinions, Registrants
*We assume lag of 1 year between fiscal year of the opinion and year of origination of CL review. For example, opinions for fiscal 2014 are likely to be included in 10K’s filed (and subsequently reviewed by SEC) in 2015, therefore percentages for fiscal year 2014 are not shown.
Source: Audit Analytics.
Disclosure Effectiveness
Dave Lynn, a partner at Morrison and Foerster and a former chief counsel at Corp Fin, agrees that his old stomping grounds have become more efficient in determining what issues to raise; and once raised, seeing the process through to completion. He sees more focused reviews, sticking to material issues or to just a few areas important for that company or industry.
There seems to be a broader feedback effect in play, as a result of the SEC’s decision 10 years ago to make comment letters public. “The transparency around the comment process has made it a lot easier to comply, as you can now anticipate a lot of the comments that the staff might raise,” Lynn says. “In some cases a company may choose to address those concerns in a way that forestalls them from making a comment on your filing.”
A byproduct of this transparency, Lynn notes, is that auditing firms “are cranking out hundreds of pages of documents summarizing the comment process and general observations.”
While the information in comment letters is powerful, Lynn also warns that it may be “too powerful.” SEC staff have emphasized that “a comment to one company doesn’t mean that it’s applicable for all companies,” he says, so individual registrants should write their disclosures in a way that’s effective for their company—not to address all comments they’ve seen raised by SEC staff in someone else’s filings.
Lynn also credits Corp Fin’s Office of Disclosure Standards, and a general increase in staffing after the Sarbanes-Oxley Act of 2002, as likely factors improving the comment letter process.
The number or registrants who copy their audit firms while responding to SEC comment letters has risen by 1 percent in the last five years. Neither Jacobs nor Lynn considered the CCing of auditors to be significant. “I would not look to whether the auditor is actually copied or not copied on the letter to be indicative of the level of involvement,” says Jacobs, who believes the decision whether to copy the auditor may be based on personal preference.
Lynn adds, “I could write a whole book about auditor-issuer relations, particularly when it comes to SEC issues, but to me, the outcome is going to be driven by the nature of issues described, and how integral the auditor has been to doing that; in a lot of cases, even if the auditor is not copied on the letter to [SEC] staff, they get a copy.”
Jacobs, recalling when Meredith Cross led the Division of Corporate Finance 2009 through 2012, says Cross was “very outspoken about companies treating their response letters similar to a public disclosure document, as far as what they would tell the staff and how they would say it.” Ultimately, if a material issue is raised, he says, it will be dealt with in a subsequent filing, or an amendment.
Lynn doesn’t read much into the length of time to close a comment letter conversation, either; that can depend on factors such as availability of SEC staff or corporate accountants at the registrant, how many people are involved in developing the information, and whether the disclosure needs to be revised.
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