For the sixth consecutive year, there has been a steady decline in the total number of comment letters issued by the SEC. In the first half of 2015, 2,877 10-K and 10-Q comment letters (1,690 UPLOADs and 1,187 CORRESPs) were filed by 933 companies. That compares to 3,717 and 4,729 letters filed in the first halves of 2014 and 2013, respectively.
We previously covered some explanations for the trend, and nothing has given us reason to expect that the trend will reverse.
In this post, we will look at common issues raised in SEC comment letters across the entire reporting landscape. The top issues in 2015 remained largely unchanged since our last issues trends report.1
There are some great resources for digging deeper into these trends. Notably, Deloitte’s “SEC Comment Letters – Including Industry Insights: What “Edgar” Told Us”, issued in October 2015, covers the whole spectrum; and EY offers a number of industry-specific publications that shed light on the issue. Both provide insightful analysis of the major trends and issues in SEC Comment Letters.
In this blog, we will discuss some less frequently covered topics that have been relatively prominent so far in 2015.2
Results of Operations: Questions related to the MD&A section, and in particular to the Results of Operations, were again at the top of the list of common issues raised in comment letters. In 2014 and 2015, about 15% of all letters included at least one Results of Operations question, compared to about 17% in 2013. Types of questions remained similar to what we saw in 2014. These comments included requests to quantify the impact of items contributing to period-over-period changes, and requests to provide additional disclosure related to favorable or unfavorable market events that may have a significant impact on future trends and developments. SEC Releases 33-8350 and 33-6835 and Item 303 of Regulation S-K are frequently cited.
We note that you identify several factors contributing to the decrease in gross profit margin and increase in SG&A expenses as a percentage of sales. Please tell us whether you are able to quantify the impact of the factors you identify that had an impact on gross profit margin and SG&A expenses as a percentage of sales and, if so, what consideration you gave to quantifying the impact of such factors in your discussion of these line items.
One interesting development particularly prominent in MD&A-type comments is the expansion of SEC reviews beyond annual and quarterly reports. We have seen the SEC issue a number of comments relating to the consistency between earnings press releases, conferences calls, and MD&A disclosures. For example:
We note that in your earnings call for the fourth quarter of 2014 you discussed management’s expectations regarding growth trends in your end markets, such as domestic and UK construction, but you do not discuss these or other trends and expectations in MD&A. In future filings, please consider providing a more fulsome trends discussion. Refer to Item 303(a)(3)(ii) of Regulation S-K.
Fair Value Measurement:3 Many of the fair value comment letters released in 2015 questioned the use of unobservable inputs and valuation techniques, placing additional focus on whether disclosures were consistent between similar asset types. Many of the recipients were finance and insurance companies,and ASC 820-10-50-2 was frequently cited.
Notes to Consolidated Financial Statements
1. Your discussion on page F-21 of how valuations for your level 2 fixed maturities are derived appears to be vague. Please provide us, for each “class” (refer to comment two) of Level 2 fixed maturity securities, the valuation technique(s) and inputs used in your fair value measurement. Refer to ASC 820-10-5-2bbb.
2. Refer to your disclosure of fixed maturity securities herein and in Note 2. It is unclear to us why further disaggregation of your fixed maturity securities is not warranted. Please provide us analyses under ASC 320-10-50-1B and ASC 820-10-50-2B supporting your presentation of fixed maturity securities by “major security types” and “classes”. In this regard, please tell us why you did not further disaggregate corporate securities, agency residential, foreign government securities and foreign corporate securities.”
The declining price of oil triggered a wave of comments related to the impact of commodity prices on the fair value of oil properties. Other comments questioned fair value inputs in the impairment testing of oil and gas properties.
Note 6. Fair Value Measurements, page 81
Provide us with a reasonable detailed summary of the impairment testing performed for your proved crude oil and natural gas properties as of December 31, 2014. Identify and explain your basis for all key assumptions made, including those related to prices, volumes, costs and discount rates. To the extent that revenues from quantities other than proved reserves were included in the analysis, clarify those quantities and explain whether and how they have been risk adjusted. To the extent that you have used a 10% discount factor, explain how that is consistent with the disclosure in your risk factors section which indicates “the 10% discount factor we use when calculating discounted future net revenues may not be the most appropriate discount factor.”
Non-GAAP: Non-GAAP was the only topic that increased as a percentage of total letters in 2015. The issues ranged from requests to justify the classification of certain adjustments as “infrequent” or “non-recurring”, to requests to reconcile non-GAAP metrics with the most comparable GAAP metric.
2. As a related matter, we note you have described the non-GAAP adjustments as unusual or infrequent here and on page 53. Tell us how you were able to determine that all of these adjustments are unusual or infrequent as some of them appear to have occurred in prior periods. Alternatively, revise your disclosure in future filings to properly characterize your description of these adjustments. Refer to Question 102.03 of the Compliance and Disclosure Interpretations for Non-GAAP Financial Measures which is available at http://www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm.”
As we discussed in one of our previous blogs, SEC comments can be divided into two broad categories: (1) comments specific to the company whose filings were being reviewed; and (2) comments broadly applicable that were issued to a large number of companies within a given industry, subsequent to a review of industry-wide practices. It appears that the SEC’s interest in AFFO presentations by REITs belongs to the second category.
We note your disclosure that FFO is adjusted to eliminate the impact of non-recurring items when calculating AFFO. Given the nature of these adjustments, it is not clear why they are non-recurring. Please clarify and/or revise to remove reference to non-recurring in future filings. Reference is made to Question 102.03 of the Division’s Compliance and Disclosure Interpretations for Non-GAAP Financial Measures. Additionally, it appears that you have made certain non-cash adjustments to arrive at AFFO, a performance measure. Please tell us the nature of these adjustments, why the exclusion of these amounts is beneficial to investors, and why you have not adjusted for the cash portion of similar expenses.
Internal controls – COSO Framework: In May 2013, COSO released an updated framework for companies to use in evaluating their Internal Controls over Financial Reporting. The 1992 Framework entered a transitional period that ended on December 15, 2014, at which time it was considered to be superseded by the 2013 Framework. In some comments, SEC staff requested clarification about the use of either the 1992 or 2013 Framework in a company’s 2014 ICFR assessment:
Comment #2: We note that Management’s Annual Report on Internal Control Over Financial Reporting does not identify the version of the Committee of Sponsoring Organizations of the Treadway Commission’s Internal Control ~ Integrated Framework that was used to perform your assessment as required by Item 308(a)(2) of Regulation S-K. Please revise future filings, including the requested amendment, to include a report that identifies the version of the COSO Integrated Framework you used in the assessment, ~ i.e., whether you used the 1992 Framework or the Updated Framework issued in 2013.
These are just a few of the areas of interest we noted in our ongoing analysis of SEC Comment Letters. Our database covers 270,000 comment letters that have each been reviewed and categorized according to our proprietary taxonomy of almost 3,000 issues and citations. For more information about comment letters, please contact us at firstname.lastname@example.org.
i. 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. Based on historical experience, for about 10% of the comments dissemination days is more than 90 days after the filing date of the letter.↩
ii. 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.↩
iii. 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.↩