Technology has greatly improved our lives. Without it, we wouldn’t be able to surf the net, track our steps, talk through watches, or use stories of weak cell signals and dead car batteries to get us out of trouble. But sometimes technology really does let us down, even when it seems too much like a “dog ate my homework” story to be true. Take for instance, a recent incident of miscommunication involving Axon Enterprise [AAXN].
According to the company, the “miscommunication” was caused by an overly aggressive spam filter that quarantined not one, but two separate emails from the SEC including official Comment Letters on the company’s financial reports. The CFO learned about the SEC comment letters only after they were published on Edgar. When the stock market learned about the accident, the stock tumbled to close at $23.01 on October 20th.
So what exactly are SEC comment letters, and what happens if they are left unanswered?
First, it is important to distinguish between an SEC inquiry and a comment letter. SEC comment letters are routine, periodic Corp Fin reviews of financial statements. Each year about 50% of the companies are subject to SEC review. Yet, the comments are issued only if the SEC has questions, or needs a clarification. Each year, thousands of companies receive comments on their 10-K and 10-Q filings.
When a company receives a comment letter, it does not necessarily mean that the SEC disagrees with the company’s accounting practices. In fact, most of the SEC’s comments are resolved by providing additional disclosure in subsequent filings. Only a very small percentage of comments require an actual restatement of financial statements.
So, while it may not be a big deal to receive an SEC comment letter, the failure to respond to one is a different story. For example, companies with incomplete reviews might be up for a surprise next time they attempt to raise capital; the SEC will not declare a registration effective until all its comments are cleared.
While most companies do manage to respond to the SEC in a timely manner, Axon Enterprise [AAXN] is not the only company that (for one reason or another) has left SEC letters unanswered. Since 2005, more than 1,000 companies have failed to provide responses to SEC comment letters. Most of these companies were listed on OTC, and only about 12% had market cap of more than $50 million. (Read more about comment letters with no response in an earlier post.)
So far, we have not seen any reference to unanswered comment letters in the Disclosure Controls section. However, we were wondering whether important emails indefinitely retained in the spam folder should be taken in the context of the overall controls environment of the company.
A look at the company profile page available on our website shows various red flags tagged to Axon Enterprise [AAXN], including these three filings:
- 10-Q dated 2016-05-10, Axon Enterprise [AAXN] identified a material weakness over recording of liabilities.
- 10-Q dated 2016-08-10, an additional material weakness (this time, over revenue recognition) was identified.
- 10-Q dated 2017-05-10, yet another material weakness (over accounting for taxes) was disclosed.
As of the date of this report, ICFR and Disclosure Controls were still ineffective. The company had other red flags, including out-of-period adjustments and late filings.
To summarize, the 8-K filing stated that the company “intends to respond to the SEC within the next seven days”. In our opinion, responding promptly and to the point is always the best approach – and especially so considering the circumstances. Typically, the comment letters are disseminated 20 days after the resolution of the comments. On average, it takes 1- 2 rounds (and about 40 days) to resolve all the comments, so we would expect Axon Enterprise responses made public within next 60 days, give or take.
To request a copy of the Axon Enterprise report which includes a complete list of red flags, contact us at email@example.com or call (508) 476-7007.