2014 SEC Comment Letters: Trends and Issues

The number of SEC comment letters regarding 10-Ks and 10-Qs issued during the first six months of 2014 decreased about 25% compared to the same period in 2013. The SEC is required to review each registrant’s financial statements at least once every three years, and these reviews often lead the SEC to send letters to the company asking management to clarify a point or expand on a disclosure or a number of other such issues. Companies have to respond, and some comments can turn into fairly long conversations drawn out over many months and across a number of letters.

What are the most common topics? Issues range from the usual suspects – MD&A, fair value, revenue recognition – to the unusuals, like questions about artwork and graphics used in the 10-K or 10-Q. Back in May, we analyzed comment letters by issue type for companies with a market cap greater than $100M. In this post, we will look at the most common topics referenced by the SEC in comment letters dated between January 1, and June 30, 2014, which we will compare to the same period in 2013.

The SEC released 3,505 letters (2,041 UPLOADs and 1,464 CORRESPs) referring to 10-K and 10-Q filings in the first six months of 2014. This represents a roughly 25% decline from the 4,716 letters (2,692 UPLOADs and 2,024 CORRESPs) that were released during the same time period in 2013. The total number of companies involved in these comment letters decreased about 24%, from 1,439 unique registrants in the first half of 2013, to 1,097 in 2014.

2014_Issues Breakdown_Table 1

As evident from the table above (including both UPLOAD and CORRESP letters), while the major topics discussed remained fairly consistent compared to 2013, the frequency of these topics declined in 11 out of 12 categories. Only comments related to acquisitions and the like saw an increase in the first half of 2014.

In addition to the major trends that remained stable in the past few years, we identified a few additional topics that affect particular industries or types of registrants, particularly: Results of Operations, Non-GAAP Measurements, Internal Controls, and more.

Results of Operations: One of the most common topics that triggered SEC Comment Letters relates to disclosures made in the Results of Operations section. The SEC frequently requested additional information regarding changes in core accounts such as revenue or cost of sales. In many cases, SEC Release No. 33-8350 was cited. We also noticed a trend in the SEC requesting that companies provide additional disclosure if increases or decreases in core accounts appeared to be related to an emerging trend in the business or industry.

We note that you do not quantify the impact of the various factors that affected your revenues from period to period. For example, you state that the Electrical Power and Infrastructure Services revenues were negatively impacted by lower revenues related to renewable energy projects, but you do not quantify the impact. Similarly, you do not quantify the impact of the increase in pipeline projects in the Oil and Gas Infrastructure Services segment. These are just examples. In future filings please quantify the effects of such factors and also discuss whether you believe these factors are the result of a trend, and, if so, whether you expect it to continue and how it may impact your financial condition and results of operations. Please also discuss the impact of individual material projects, as appropriate. See Item 303 of Regulation S-K and SEC Release No. 33-8350. Please supplementally show us what your revised disclosure will look like in future filings. 

Non-GAAP Measurements:  What was a common topic in 2013 continues to be so in the current year. Concerns about non-GAAP measurements in 2014 letters included: undue prominence in the presentation of non-GAAP measurements (including presentation of an entire financial statement on a non-GAAP basis), requests to clarify why the non-GAAP metric might be useful to investors; and misleading labeling of non-GAAP metrics.

Please revise your presentation of non-GAAP financial information in future filings to discuss, for each specific measure, why you believe that presentation of the non-GAAP financial measure provides useful information to investors regarding your financial condition and results of operations.

Internal Controls: Effectiveness of Internal Controls over Financial Reporting remained a concern in 2014. Over 100 ICFR-related letters were issued to 50 companies in 2014. Two of the most common issues addressed by the SEC were requests to clarify the impact of previously identified errors on the company’s ICFR evaluation and which framework was used in the evaluation of ICFRs;

Management’s Annual Report on Internal Control over Financial Reporting

Please revise future filings to clarify the version, 1992 or 2013, of the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework you utilized when performing your assessment of internal control over financial reporting.

Use of Operational Metrics: Comments on the use of operational metrics ranged from questions about the definitions of specific metrics, such as backlog, to the use of online sales in the calculation of comparable store sales.

Example 1 – Backlog: Please show us how you will revise your future filings to explain the criteria you use to determine when an order is considered firm and therefore included in your backlog.

Example 2 – Online Sales: We note your comparable sales increase includes online sales. In future filings, please expand your disclosure to quantify how online sales impacted your comparable sales. Otherwise, to the extent online sales did not have a meaningful impact to your comparable sales metric please disclose that fact in your filings.

Subsidiary Guarantor Financial Information: The applicability of Rule 3-10 of Regulation S-X remained a frequently commented upon topic in 2014. In the first half of 2014, at least 23 companies received 44 letters that cited Rule 3-10. Comments included requests to confirm that subsidiaries are 100% owned and that guarantees are full and unconditional, as well as requests for presentation of separate subsidiary financial statements;

Condensed Consolidating Financial Information

Please revise your disclosure in future filings to clarify that all of the guarantor subsidiaries are 100% owned by the parent as defined in Rule 3-10(h)(1) of Regulation S-X,if correct, and confirm to us that you will make this revision. Please note that “wholly-owned” has a different meaning than 100% owned. Please also refer to Rule 1-02(aa) of Regulation S-X for guidance.

These are just some of the areas of focus we have noticed in our analysis of SEC comment letters. Our database covers 240,000 comment letters that have each been reviewed and categorized according to our proprietary taxonomy of almost 3,000 issues and regulations.

Note 1: UPLOADs are letters sent from the SEC to a company, and CORRESPs are response letters sent from a company back to the SEC.

Note 2: One important thing to remember is that comment letters are normally released only 20 days after the resolution of all the comments, so the numbers of letters and number of registrants may change for the 2014 period.

Note 3: Fair Value Taxonomy include questions referring to applicability of ASC 820, as well as fair valuation of assets during acquisitions, fair valuation of goodwill and valuation of stock options under ASC 718.

Note 4: Selection of more than one taxonomy is common for certain types of comments. For example, comments requesting additional information about the impact of repatriation of foreign taxes on liquidity would obtain both the “liquidity” and “taxes” taxonomies.

Note 5: The examples selected are for illustrative purposes only. We did not attempt to provide a comprehensive list of topics discussed or to cover all industries or sectors.