The comment letter panel at the Conference on Tuesday discussed the most frequently addressed areas in SEC staff comments. The panel comprised representatives from the SEC staff, public accounting and the legal profession. Panelists provided a good indication of the issues to which registrants should pay close attention as they prepare 2023 Form 10-Ks and 2024 Form 10-Qs.
During a separate panel, staff in the SEC Division of Enforcement discussed enforcement trends focused on accounting, auditing and financial reporting matters.
“With disclosure transparency being a major concern of the SEC, understanding comment letters trends can help a registrant’s disclosure committee review SEC filings to ensure they provide the robust discussion the SEC staff is expecting. And registrants should expect the staff to continue probing if a response is not specific enough."
— Erin McCloskey, KPMG Partner
Top regulatory comment topic: MD&A
MD&A disclosures have traditionally been a major focus in comment letters – and remain so – with MD&A being one of the top recent comment letter topics.
Critical accounting estimates
Kevin Woody, SEC Accounting Branch Chief, cautioned that the critical accounting estimates disclosure should not be a repeat of the significant accounting policy disclosure in the financial statement notes.
Instead, the disclosure must include the quantitative and qualitative information about the critical accounting estimate. The disclosure should focus on the methods and significant assumptions in estimates, and include the degree to which the estimates and underlying assumptions have changed, and the sensitivity of the estimates to the methods and assumptions.
Woody also noted that the SEC’s Division of Corporation Finance is noticing more MD&A discussion of the effect of inflation. Such disclosures need to be specific, not just based on high-level trends.
Results of operations
Thomas Kim, partner with Gibson, Dunn & Crutcher, noted that some MD&A disclosures about the results of operations do not sufficiently explain why operating metrics (such as revenue) are changed, even though the same companies may provide more detail through other communication channels such as earnings calls and investor presentations.
Beware boilerplate market risk disclosures
Registrants provide quantitative and qualitative disclosures in their annual reports about market-rate exposure risks (the ‘S-K Item 305 disclosures’). While Corp Fin staff discussed these disclosure requirements with particular focus on the financial services industry, many of the points apply more broadly to other registrants.
Corp Fin is concerned that the S-K Item 305 disclosures are often boilerplate. The staff emphasized the importance of adequately describing the interest-rate and liquidity risks that financial institutions are facing in the current economic environment. To make disclosures more meaningful to investors, the staff recommended including information such as key assumptions related to interest-rate risk and information about available sources of liquidity and potential costs and issues of accessing those sources.
Pay vs performace (PvP) rules
PvP had been discussed in the Corp Fin panel earlier in the day. In this session, Woody discussed how the division is approaching its reviews related to this rule. Specifically, Woody discussed that the reviews for 2023 proxy disclosures have been focused on understanding how registrants are responding to the new rule and identifying potential challenges with compliance.
Woody noted that generally registrants have made a good faith effort to comply but highlighted a few areas in which registrants may have fallen short, including:
lack of clarity regarding disclosing changes in assumptions used in the calculation of compensation actually paid;
unclear disclosure of the calculation of non-GAAP measures as the company selected measure; this information may be cross-referenced within the same proxy filing but not to other filings such as the Form 10-K; and
omission of the disclosures of the relationship between executive compensation and company performance in whole or in part.
The staff also noted that graphical presentation of the relationship disclosures is more effective and informative than narrative presentation. Woody noted that comment letters associated with PvP rules are aimed prospectively at future proxy filings.
Best practices for responding to comment letters
To make the comment letter process run smoothly, panelists suggested coordinating with your service professionals early in the process. Your audit team is an important resource, as are the national experts within many of the accounting firms. Securities counsel also plays an important role in crafting the response; many law firms have expertise in the topical issues seen in comment letters.
“KPMG audit teams and our Department of Professional Practice professionals routinely assist registrants in analyzing comment letters about accounting matters and identifying whether potential responses are likely to be sufficiently specific to resolve open comments with the Corp Fin staff. Early engagement is key to a smooth process."
— Danny Zamora, KPMG Partner
SEC enforcement focused on investor protection
The SEC recently announced it filed 784 total enforcement actions in fiscal year 2023, a 3% increase over fiscal year 2022 – including 501 original enforcement actions, an 8% increase over the prior fiscal year. The original enforcement actions included billion-dollar frauds and emerging investor threats involving crypto asset securities and cybersecurity. Further, the market participants charged were diverse, from public companies and investment firms to audit firms and social media influencers.
The Enforcement Division’s focus continues to be on investor protection. Enforcement Division staff emphasized the critical role of accurate and complete financial reporting and disclosure in maintaining investor trust and the overall health of the securities markets.