Questions from the SEC? Don’t panic!
(Editor's note: The first of two parts.)
If you haven't been through the SEC's review and comment process before, it can be a bit scary. As regulators respond to cries for more scrutiny of public companies post-financial crisis, CFOs should become accustomed to more SEC letters.
If you thought that increased regulation from the Sarbanes-Oxley Act of a few years ago would diminish over time, think again. The SEC is under the public heat lamp these days. It ignored warnings of the Madoff Ponzi scheme and new evidence unearthed in the Lehman Brothers catastrophe shows the SEC did more of the same. Politicians will not be pleased when a report emerges before a congressional committee in April.
Here's how to deal with an SEC letter. First, let's look at an overview, starting with the filing of an initial public offering (IPO) that raises money for general corporate purposes and makes shares available for purchase to public investors.
Every time a company files an IPO with the SEC, the SEC staff grades it. In order to make the filing effective, it needs a passing grade. If it doesn't garner a passing grade, you can expect a formal letter from the SEC staff requesting more information.
If your company is already public and making regular annual and quarterly filings for such events as material events or change in management, your filing won't be officially graded. But it will be reviewed by SEC staff, and if they aren't clear about the filing, they'll send you a comment letter.
The SEC doesn't review every one of your filings. They review a sample of them. Sarbanes-Oxley Act requires staff to analyze a 10-Q at least every three years. How will you know when your company is under review? You won't and neither will you hear from them if everything looks okay. You'll just know if they don't like what they see or have more questions.
How to respond to an SEC comment letter
If you receive a comment letter, it will be delivered by official mail, be from a particular staffer in the agency, and signed under the name of the supervising officer. Your first response may be an emotional one, but don't feel singled out. Understand the SEC is required by law to routinely review and question filings. Also realize that the SEC takes comment letters seriously and doesn't send them without some consideration.
The first thing to keep in mind is the timetable the letter delineates. It will give you adequate time to respond to questions - normally 10 days. If you don't think you can answer the question properly - this is key - call the person who wrote the letter (they always provide a phone number) and ask for an extension. Extensions are rarely denied. You must set a date of the extension, or when you'll have your response back to the SEC.
Don't jump the gun and think you have to restate your financials or some other drastic measure. Call the SEC and clarify what they are asking you about. Make sure you understand the question. Many companies fail to do this and spend a lot of time addressing the wrong issues. Instead of satisfying the examiner, they get another letter.
If you are not careful in the first response, things can get escalated. You've created a credibility problem for your company. Now your level of scrutiny rises. You hear from companies, "I just want to get this done and get down the pike." That's self-defeating. Responding thoughtfully is more important than responding quickly. In fact, the SEC may be asking a simple question of fact, rather than criticizing the legality of your reporting. What seems like common knowledge to you may not be to the examiner, who might just need simple information about your industry.
For example, in answering a routine SEC comment letter, you might think you didn't need to consolidate financial statements for three different operating units of your company and you gave three reasons why, but left out the key fact that would require consolidation reporting. Your answer might generate another letter and more questions. So you're on to the second round.
In the second round, the fact that you left out this key fact in the first response letter creates a credibility issue with the SEC. That leads to a higher level of scrutiny. You should have gathered all the facts, called the SEC and made sure 10 days was enough time to respond.
Gather the right team
Make sure you've involved all the right people, which depends on the nature of the comment. At minimum, you should have securities counsel and your auditor involved in the process. Distribute the comment letter, have everyone review, then set up conference call. Go through comments one by one and assign responses to key team members. Each team member may draft a response, or one person may draft the response. You can send the response back by general mail, fax it or scan and email it.
Now, if you've gone to the third comment letter and the SEC still isn't satisfied, you might be at odds about determining what is material to report to the public. It's your right to present your argument. The SEC might not agree and ultimately their belief has more weight than yours, but they could be convinced with a good argument.
If there's still a disagreement, you can 1) capitulate or 2) call in a supervisor and appeal to the office of the chief accountant. Now the affair has taken three months. After presenting written arguments, you can expect to hear the ruling in 20 days. The chief accountant's ruling is final.
One thing to remember: All of these comment letters and responses are eventually public information reported on the SEC's EDGAR site, even first comment letters. So choose your responses carefully. On the plus side, you can search previous comment letters involving companies in your industry and learn how the issues were resolved.
It might help you get to the end game more quickly.