Reducing the Fear of an SEC Comment Letter

Understanding the process and planning an effective response are important steps in addressing SEC comment letters.

A panel at the Financial Executives International annual Current Financial Reporting Issues Conference (CFRI) said the prospect of the U.S. Securities and Exchange Commission's Division of Corporation Finance (CorpFin) questioning aspects of a company’s 10-K or 10-Q filing can be unsettling, but placing the staff’s comments in context and planning the organization’s response can mitigate the risk of additional disclosures and potential sanctions.

Christine Davine, partner and national director of SEC services at Deloitte, said about half of all public companies are reviewed in a given year, with about a third of those reviews resulting in comment letters. This compares with three-quarters of company filings generating comments about a decade ago.

“This has happened for a couple of reasons,” Davine said. “Companies have seen a number of comment letters, and they’re getting better about their disclosures. The firms publish books on comment letter insights, and those are helpful to registrants in preparing disclosures and knowing what to focus on.”

For instance, Davine said, leading causes of comment letters today include management discussion and analysis (MD&A) sections of 10-Ks, fair value measurements, revenue recognition, non-GAAP measures, and other financial reporting topics. Deloitte has recently published the latest edition of its annual review of comment letters and resources for preparers.

Drafting a Response

If a firm does receive a comment letter, it will have to prepare a response. Depending on the issue at hand, that response may resolve the issue, or it may lead to another round of correspondence.

“The most important thing you can do is cite the literature,” said Brian Lane, a partner with the legal firm Gibson, Dunn & Crutcher. “I can’t tell you how many controllers make an argument while ignoring the literature. The best way to shut down [a review] is to say ‘we looked a paragraph X and sub-paragraph Y, and we think we followed precisely what GAAP requires.’ That’s a powerful answer that will help get [your issue] resolved.”

Along with citing accounting literature, another potentially useful strategy is calling the CorpFin staff to discuss their concerns.

“The staff doesn’t want to debate the letter on the phone,” Lane said. “Everyone wants to get CorpFin on the phone to tell them how wrong they are, but the staff doesn’t want to have that conversation. You have to characterize it as a clarification. You can call to say you don’t understand what they’re getting at, and ask them to explain their concerns. Then you can start talking.”

Lane advised controllers to prepare for a SEC discussion by reviewing the issue with their auditor, the audit firm’s national office, and legal counsel to develop talking points for the call. Preparing and reading a script is likely to be counterproductive because doing so reduces engagement with the reviewer.

“Some people are just nervous – they shouldn’t be talking,” Lane said. “Some people get nervous about the talking to the government. They shouldn’t be talking either.”

Davine said it could be helpful to cite other companies within your industry that are applying the same treatment to similar circumstances as well as the accounting literature.

Monitor SEC Concerns

A helpful step in reducing the risk of receiving an SEC comment letter is keeping up with best practices in financial reporting and paying attention to topics CorpFin views as priorities.

For example, Davine said, reviewing comment letters industry peers have received can provide insights into the SEC staff’s thinking about current or emerging disclosure issues.

“As your disclosure process ends after a quarter or year-end, go to the EDGAR system to see what comment letters your competitors received,” Davine said. “Those disclosure suggestions can be useful to your investors and your company. You should also look across industries, because once one office starts giving comments, those migrate to other industries. Look across industries to see what the staff is thinking.”

Similarly, Lane said, understanding the types of comments competitors are receiving can help a registrant understand the potential gravity of the CorpFin’s concerns. For instance, a staff comment about a given disclosure may sound serious, but seeing that industry peers have received the same comment can provide assurance that your company isn’t being singled out.