The Division of Corporation Finance’s Disclosure Review And Comment Process
Those that regularly read my blog know that I sometimes like to go back to basics. This blog will revisit and discuss the SEC’s Division of Corporation Finance (“CorpFin”) comment and review process. Back in March 2016, I wrote about the SEC comment and review process, including a description of the internal review process, review levels and breakup of industry sector reviewers. That blog can be read HERE. Since that time, the SEC has eliminated the Tandy Letter requirement. See HERE. Furthermore, on March 22, 2018, CorpFin updated its “Filing Review Process” page on the SEC website.
At the end of each calendar year, the big four accounting firms generally publish studies on CorpFin’s Comment Priorities. Their studies, and other recent publications, uniformly found that the number of comments, especially in a registration process, has dramatically declined. I have noticed this trend as well in my practice.
Also consistent in reports is a list of recent comment priorities, including: (i) non-GAAP financial measures (see HERE for more information on this topic; (ii) application of the new revenue recognition standards; (iii) disclosure of cyber risks and cyber incidents; (iii) management, discussion and analysis presentation and disclosures, including segment reporting and income taxes; (iv) disclosures of intangible assets and goodwill; (v) state sponsors of terrorism; (vi) related to acquisitions, mergers and business combinations; and (vii) signatures, exhibits and agreements.
This past year, in September 2017, the SEC Office of Inspector General published an Evaluation of the Division of Corporation Finance’s Disclosure Review and Comment Letter Process (the “September 2017 Report”). The purpose of the Inspector General’s examination and report was to review CorpFin’s process for issuing, tracking and facilitating public access to comment letters and related correspondence.
In addition to summarizing the September 2017 Report, this blog includes information on the updated CorpFin Filing Review Process page and general commentary and information on the process.
The SEC Division of Corporation Finance (CorpFin) reviews and comments upon filings made under the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”). The purpose of a review by CorpFin is to ensure compliance with the disclosure requirements under the federal securities laws, including Regulation S-K and Regulation S-X, and the general anti-fraud provisions which require disclosure of material information necessary to make required disclosures, not misleading. The standard for required disclosure is generally the materiality of the information. In TSC Industries, Inc. v. Northway, Inc., the U.S. Supreme Court defined materiality as information that would have a substantial likelihood of being viewed by a reasonable investor as having significantly altered the total mix of information available.
CorpFin selectively reviews filings, although generally all first-time filings, such as an S-1 for an initial public offering or Form 10 registration under the Exchange Act, are fully reviewed. The Sarbanes-Oxley Act of 2002 requires that CorpFin review all public companies at least once every three years. Section 408 of the Sarbanes-Oxley Act requires CorpFin to focus on companies that have the largest market capitalization. Section 508 of the Sarbanes-Oxley Act specifies certain factors that the SEC should consider when scheduling reviews, including market capitalization, financial restatements, volatility of the company’s stock price and the price/earnings ratio.
There are three basic levels of review. A review by CorpFin can be a “full review” in which CorpFin will review a filing from cover to cover, including both legal and accounting aspects and basic form for compliance with the federal securities laws. A partial review may include either legal or accounting, but generally a partial review is related to financial statements and related disclosures, including Management Discussion and Analysis of Financial Condition and Results of Operations, and is completed by CorpFin accounting staff. A review may also be a targeted review in which CorpFin will examine the filing for one or more specific items of disclosure. Moreover, although not a designated level of review, CorpFin sometimes “monitors” a filing, which is a term used for a light review.
Reviewers are appointed files based on industry sectors. CorpFin has broken down its reviewers into the following 11 broad industry sectors: healthcare and insurance; consumer products; information technologies and services; natural resources; transportation and leisure; manufacturing and construction; financial services; real estate and commodities; beverages, apparel and mining; electronics and machinery and telecommunications. Each industry office is staffed with an assistant director and approximately 25 to 35 professionals, primarily accountants and lawyers. Each filing has more than one reviewer with a frontline contact person and supervisor. A full review file will have an accounting and legal reviewer as well as a supervisor.
Internally at CorpFin, a file will have a reviewer and an examiner. The examiner conducts an initial review and recommends comments to the reviewer. The reviewer may accept the examiner’s work, add comments or remove proposed comments. In addition, other CorpFin support offices may propose comments for a particular company. Each participant in the process is required to keep detailed notes and reports and upload the information into an internal workstation.
Neither the SEC nor the CorpFin evaluates the merits of any transaction or makes an assessment or determination as to whether a transaction or company is appropriate for any particular investor or the marketplace as a whole. The purpose of a review is to ensure compliance with the disclosure requirements of the securities laws. In that regard, CorpFin may ask for increased risk factors and clear disclosure related to the merits or lack thereof of a particular transaction, but they do not assess or comment upon those merits beyond the disclosure.
Comment Letters and Responses
Comment letters are based on a company’s filings and other public information about the company. For instance, CorpFin will review press releases and a company’s website, management communications and speeches, and conference presentations in addition to the company’s filings with the SEC. In comment letters, CorpFin may ask that a company provide additional supplemental information to the staff (such as backup materials to justify factual information such as reference to reports, statistics, market or industry size, etc.), revise disclosure in the document, provide additional disclosure in the reviewed filing or provide additional or different disclosure in future filings. Where a change is requested in future filings, intended disclosures may be provided in the comment letter response for SEC advance approval.
A company generally responds to the particular comment letter with a responsive letter that addresses each comment and, where appropriate, amended filings on the particular report(s) being commented upon. The response letter may refer to changes made in a filing in response to the comment or provide reasoning or explanations as to why a change was not made or in support of a particular disclosure. CorpFin then may issue additional comment letters either on the same question or issue, or additional questions or issues as it continues its review, and analyze the company’s responses. Where a comment letter asks for additional disclosure in future filings, proposed language should be provided to avoid an additional comment once the disclosure is made.
Each comment response should clearly present the company’s position on the pertinent issue in a way that will persuade CorpFin that it is the correct position. Comment responses should cite applicable SEC rules and guidance, and accounting authority (as the comments themselves most often do). Responses should explain how the company’s approach serves to satisfy the SEC’s requirements while providing good disclosure to investors. Responses should address the company’s unique facts and circumstances, and should avoid conclusory or argumentative statements. If it is the company’s position that the technical application of the rule will place too large of a burden on the company, the company should explain how it is burdened and how the alternative provided by the company will provide adequate disclosure for investors.
The comment-and-response process continues until the staff has resolved all comments. No sooner than 20 business days after completion of its review, the SEC will upload all comment letters and responses to the EDGAR database. These comment letters and responses are searchable but are organized by company, not topic, making particular topic searches difficult. When generally searching for comments and responses on a specific topic, third-party advanced searching software is helpful.
Although the basic process involves letters and responses, the CorpFin staff is available to discuss comments with a company and its legal, accounting and other advisors. The process can and often does involve such conversations. CorpFin will not give legal or accounting advice, but it will talk through comments and responses and discuss the analysis and adequacy related to disclosures. The initial comment letter received from CorpFin will have the reviewer’s direct contact information. The back-and-forth process does not require a formal protocol other than the required written response letter. That is, a company or its advisors may engage in conversations regarding comments, or request the staff to reconsider certain comments prior to putting pen to paper.
Moreover, CorpFin encourages this type of conversation, especially where the company or its advisors do not understand a particular comment. The staff would rather discuss it than have the company guess and proceed in the wrong direction. Where the staff suggests that a company should revise its disclosure or its financial statements, the company may, and should as appropriate, provide the staff with a written explanation of why it provided the disclosure it did. This explanation may resolve the comment without the need for the requested amendment. A CorpFin review is not an attack and should not be approached as such. My experience with CorpFin has always been pleasant and involves a type of collaboration to improve company disclosures.
A company may also “go up the ladder,” so to speak, in its discussion with the CorpFin review staff. Such further discussions are not discouraged or seen as an adversarial attack in any way. For instance, if the company does not understand or agree with a comment, it may first talk to the reviewer. If that does not resolve the question, they may then ask to talk to the particular person who prepared the comment or directly with the legal branch chief or accounting branch chief identified in the letter. A company may even then proceed to speak directly with the assistant director, deputy director, and then even director. Matters of legal disclosure or application of GAAP accounting principles are not an exact science, and discussions are encouraged such that the end result is an enhanced disclosure by the company and consistent disclosures across different companies. The SEC provides all of these individuals contact information on its website and will willingly engage in productive conversations with a company.
When responding to comment letters and communicating with SEC staff, it is important that a person who understands the process, such as SEC counsel, take the lead in communication. Responses should be consistent, both related to a particular comment letter and over time. A company that flip-flops on accounting treatment or disclosures will lose credibility with the SEC and invoke further review and comments.
CorpFin is also willing to provide a reasonable amount of extra time to respond to comment letters when requested. Most comment letters request a response within 10 days. CorpFin is usually willing to give an extra 10 days but will balk at much longer than that without a very good reason by the company for the delay.
If the reviewed filing is a Securities Act registration statement, such as an S-1, the CorpFin staff will verbally inform the company that it has cleared comments and the company may request that the SEC declare the registration statement effective. Where the reviewed filing is an Exchange Act filing that does not need to be declared effective, CorpFin will provide the company with a letter stating that it has resolved all of its comments.
September 2017 Report
The September 2017 Report reveals that CorpFin is developing a new system to improve and streamline certain aspects of the disclosure review process. The new system is called the System for Workflow Activity Tracking, which is referred to as SWAT. SWAT will automate certain aspects of the review process such as providing notifications of filing review status to other review team members. In addition, SWAT will generate a draft comment letter based on comments input into and approved within the system. The reviewer or another designated member of the relevant assistant director’s staff will review and revise the draft letter to ensure that it meets CorpFin’s policies for format, tone, and content. Once the draft letter is approved, a final comment letter will be generated within SWAT.
In its examination, the Office of Inspector General found that: (i) examiners and reviewers did not always properly document comments before issuing comment letters to companies; (ii) some case files were incomplete as of the date CorpFin issued a comment letter to a company; and (iii) examiners and reviewers inconsistently documented oral comments to companies.
As a result, the Office of Inspector General made three recommendations for CorpFin to improve its internal process. In particular, CorpFin should: (i) establish a mechanism or control for staff members to trace all comments provided to companies for inclusion in examiner and reviewer reports before issuing comment letters; (ii) establish a mechanism or control that ensures the staff follows policies to upload all examiner and reviewer reports to the internal workstation before issuing comment letters; and (iii) establish detailed guidance on how examiners and reviewers should document oral comments provided to companies during disclosure reviews. The recommendations were agreed to and will be closed upon verification that the corrective measures have been implemented. It is anticipated that the full implementation of the SWAT process will effectively resolve these issues as well.
A company can stay prepared for comment letters, and responses, by making sure it has adequate internal controls and procedures for reporting. The company should also stay on top of SEC guidance on disclosure matters, which can be accomplished by ensuring that the company has experienced SEC counsel that, in turn, stays up to date on all SEC rules, regulations and guidance. Likewise, the company should retain an accountant that monitors up-to-date accounting pronouncements and guidance. The company should maintain a file with backup materials for any disclosures made, including copies of reference materials for third-party disclosure items. In responding to comments, it is helpful to review other companies’ comment response letters and disclosures on particular issues. Where the SEC has requested changes in future filings, the company and its counsel must be sure to continuously monitor to be sure those changes are included. As mentioned, the SEC reviews public information on the company, including websites and press releases and accordingly, these materials should be reviewed for consistency in SEC reports.
Although a full discussion of confidential treatment and requests is beyond the scope of this blog, a company may seek confidential treatment of materials and responses to comments under Rule 83. Rule 83 requires the company to respond to comments with two separate letters: one containing the confidential information, and the other not. Unlike confidential treatment requests under Rules 406 and 24b-2, a confidential treatment request for a comment response letter does not require that the company provide a justification for such confidential treatment. However, if a Freedom of Information Act (FOIA) request is submitted by a third party related to such comment letter response, the SEC will inform the company and request justification for continued confidential treatment. Confidential treatment under Rule 83 expires after 10 years unless a renewal is requested. Both Rule 83 and other confidential treatment rules require very specific transmittal procedures, and the documents must all clearly indicate that confidential treatment is requested.
Laura Anthony, Esq.
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Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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