How to stay off the SEC’s radar

If violence is dealt with best with by avoiding it, then so is provoking the Securities and Exchange Commission. These folks can cause you an awful headache if you manage a public company, not the least of which is immediate damaged investor confidence in the wake of a comment letter or worse, enforcement action.

So how best to live peaceably with the regulator who is not your friend, tries not to be your enemy but has enormous power over your ability to do business?

The first way is to understand and recognize the SEC’s hot buttons, or those areas that typically cause comment letters. The second is to get your financial reporting right the first time and involve the right people in the process. The third is to consult with SEC staff members in advance of your public filing. Yes, they can and will give you a heads-up on the issues they are concerned about.

Be aware of these SEC hot buttons

Hot Button #1: One of the most common areas for SEC comments is revenue recognition. This is about when you actually record sales or revenue on your books and also whether you’re recording the right amount of revenue. An outrageous example of improper revenue recognition was the infamous MiniScribe scandal, where the company was shipping bricks, instead of tape drives and recognizing the revenue at the order point. The SEC also will look closely at how much revenue you record, which can get tricky if there are other obligations or sales returns or warranty issues. Perhaps you sell a product that must be installed correctly before the customer is contractually made to pay for it. Is that the revenue recognition point? The SEC wants to know.

What galls the SEC these days is boiler-plate language that does not give the reader a clear understanding of your business. Here’s a key takeaway: Make your disclosure as specific to your company and your product as you can. Include industry context. Assume the agency does not understand your business; it takes the viewpoint of the outside investor.

Hot Button #2: The impairment (or writedown) of good will or fixed assets. In this economy, it’s common for assets to have declined in value. This could include companies that you paid over book value for during an acquisition (good will), or real estate, or a manufacturing or office building. Perhaps the demand for the product made in a facility has decreased. If the facility isn’t producing historical levels of cash flow, it may have to be impaired, or written down on your balance sheet.

You might have to hire a valuation expert to determine what “fair value” of the asset is. This might seem an unfair burden but the SEC believes it is the company’s responsibility to prove there wasn’t impairment. You’re guilty until you prove yourself innocent.

Hot Button #3: Valuation of private equity transactions. This issue arises most commonly when a company issues stock for something other than cash. It could be compensation for an employee or consultant or it could be an all-stock acquisition. The SEC is prone to question any stock transaction that is not valued at current quoted market value. This may be because the issuance of large blocks of stock or restricted stock are viewed as being worth less than the market price, but prepared to defend your valuation. Say your public company buys a private company in an all-stock deal, 20 million shares. But your company only trades 1,000 shares a day, so that any sale of shares by the acquired would tank your company stock. How did you determine the appropriate discount that should be applied to the shares, the SEC will ask.

Involve the right people early

If you get your financial reporting right the first time, things will go much smoother. Part of that is involving the right people who are supplying the right information. Although this seems basic, it is a common problem for public companies.

Get the senior level of finance and accounting people together with the business people who can explain the context and details of the transaction. Involve your outside accounting firm, when necessary.

Consult with SEC staff

You can communicate three different ways with the SEC, depending on the complexity of the issue and the level of assurance you want from the agency that you are doing things right.

The first way is a phone call. The staff member assigned to your industry will be happy to discuss your questions, but it’s important to remember that their guidance will not be binding.

The second way would be to write the SEC a letter. Any response they make will be binding, but the third method, email, is preferred by the agency. This is not the condensed version. Write it first in a separate word processing file and invite comments from your financial team. Include discussion about all pertinent facts and context. Let them know if you have consulted with your audit firm and whether it agrees with your position. Include all this in your final email to the agency, which will give its conclusion. It is a response you can rely on.

You can expect an agency staff member to call you to ensure that he or she understands all the pertinent facts and you can expect them to explain their position on issues as well. The SEC is very responsive. We recently submitted a question via email and received a phone call back within three hours. It was better to avoid a time-consuming and potentially harmful SEC letter in the first place than to respond to the letter later. We saved time, money and investor confidence.
{pagebreak:Page 1}

About the author
James Brendel, CPA, CFE, is the national director of audit and accounting for Hein & Associates LLP, a full-service public accounting and advisory firm with offices in Denver, Houston, Dallas and Southern California. He specializes in SEC reporting and assists companies with public offerings and complex accounting issues. Brendel can be reached at or 303.298.9600.