SEC comment letters, or: live the questions now!

PWC maintains a section on its website devoted to SEC comment letter trends.

Of course, the issues raised in these letters relate primarily to US GAAP rather than to IFRS, but given the commonality between the two, they might often be relevant either in anticipating questions that might be posed by regulators elsewhere or, even better, in enhancing financial statements and disclosures so as to avoid having those questions ever come up.

Many of the comments are essentially an exercise in joining the dots, for example:

  • Your website has a list of time zone abbreviations, which includes information for Iran Standard Time and Tehran, and for Syria Standard Time and Damascus. Iran and Syria are designated by the State Department as state sponsors of terrorism and are subject to US economic sanctions and export controls. You do not provide disclosure about those countries. Please describe to us the nature and extent of any past, current, and anticipated contacts with Iran and Syria, whether through subsidiaries, affiliates, partners, customers, or other direct or indirect arrangements.

It’s hard to imagine that specific point coming up too often, but in reviewing corporate disclosures, it’s extremely common to find similar discontinuities. This might happen, for instance, when certain sections of the website are written primarily from a marketing perspective, and set out certain information without thinking through its compliance-related implications. Issues also commonly arise due to inadequate updating, so that for instance the website continues to refer to a particular initiative as being active, whereas it’s clear elsewhere that this isn’t so (as an aside, it’s remarkable how often one comes across a corporate website for which key sections haven’t been revisited in months, or even years). Of course, there can be so many dots to join that it’s not so surprising if some of them fail to get connected, but they hopefully shouldn’t involve matters as crucial as, say, involvement with the world’s worst countries.

I’ll just go through a few others that caught my attention for one reason or another. On the MD&A:

  • In future filings, please provide additional information about the components of operating expenses, such as quantifying the components and the factors driving the increase and the extent to which you expect this trend to continue.

It’s too often necessary for Canadian regulators to raise this same point, or variations on it. I’ve said it before, but the only point of studying historical financial statements (assuming you’re not an academic researcher or suchlike) is in order to form expectations about the future. Canadian regulators specify that an MD&A should “provide information about the quality, and potential variability, of (the) company’s profit or loss and cash flow, to assist investors in determining if past performance is indicative of future performance.” It’s important then to distinguish between recurring and one-off items, between expenses that will generally grow in line with revenue and those that won’t, and so on. It’s remarkable how often an MD&A will provide little or no insight on this kind of thing, making it all too clear that preparers and reviewers solely regarded it as a bland compliance exercise.

It’s no surprise that comments relating to revenue recognition are common at present. Here are a couple of examples:

  • It appears from your description of the contract that you perform a variety of activities under a customer contract. Please tell us your consideration of ASC 606-10-50-17 related to the disclosure of significant judgments involved in determining that all of the contracts have a single performance obligation.
  • We note that you offer consulting and trainings as part of your services offerings. Please tell us over what period of time you typically provide these services and how you determined that point in time revenue recognition was appropriate.

Of course, that hardly covers everything that could be asked, but I pick out those two instances to illustrate that same concept of joining the dots. There’s no question that applying IFRS 15 may constitute a major technical challenge for some entities, but the end result should also (one hopes) pass a broad common sense test in that it aligns with how the entity communicates its activities. For example, an entity that gushes about its extended, multi-faceted relationships with its customers may have a tougher time arguing that its contracts consist of a single performance obligation.

According to PWC (which in turn cites work done by the research firm Audit Analytics), the number one topical area of comments over the year to September 30, 2018 was however our old friend, non-GAAP measures, spawning such evergreen questions as:

  • You disclose non-GAAP measures without presenting the comparable GAAP measures with equal or greater prominence. Please ensure any discussion regarding non-GAAP measures is preceded by an equal or more prominent discussion of the comparable GAAP measure.

The website does at least convey that the number of comment letters on the non-GAAP issue declined compared to the previous year. Whether that’s because of lasting improvement in the area, or because the SEC staff just can’t bear to spend time on it anymore, isn’t addressed…

The opinions expressed are solely those of the author

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