Dallas Securities Bar Association SEC review comments - From the auditor s perspective. Wayne Gray and Joe Blice May 21, 2012

Transcription

1 Dallas Securities Bar Association SEC review comments - From the auditor s perspective Wayne Gray and Joe Blice May 21, 2012

2 What we will cover Background on SEC reviews Interaction between accounting and legal comments (SX and SK) What do the auditors look for in comment letters and in the Company s response Potential problem areas for our clients Common accounting comments

3 Background on SEC reviews Under Sarbanes Oxley SEC s Division of Corp Finance conducts some level of review of every reporting company s filings at least every 3 years. SEC will normally review registration statements for IPO or business combination Usually issue a letter covering legal and business as well as accounting and financial disclosures Good reminder to clients 10 years in prison for destroying, altering, concealing or falsifying records

4 Interaction between accounting and legal (SX and SK) SK responses can impact financial statement positions MD&A comments Whose responsibility? Best practices on coordination

5 What do the auditors look for In comment letters: Indication of actual errors in financials or footnotes Potential restatement items Required disclosure changes in financials Amendment Prospective fix Any non-accounting comments that could affect financials

6 What do the auditors look for In Company response Inconsistency between legal / business sections and financial statements Division of Corp Fin Financial Reporting Manual

7 Potential Problems in letters or response process Auditors have to be (and appear to be) independent of the company in response process Company needs ability to respond to accounting comments without relying unduly on the auditors Our experience in dealing with the staff

8 Common accounting comments MD&A disclosure Get behind the numbers/forward looking or outlook Critical estimates and judgment/sensitivity

9 Common accounting comments Reverse mergers Acquirer for accounting purposes differs from legal acquirer SEC calls it a recapitalization of the private operating company using the public company s capital structure Accounting acquirer s history carries forward, legal acquirer s capital structure is used 4 days to file 8-K for operating company audited financials if registrant is a shell

10 Common accounting comments Predecessor financial statements Required when Registrant succeeds to substantially all the business of another company E.g. Company acquired Oct 15, 2011 that meets definition of predecessor File normal F/S as required for 8-K within 75 days In K, pick up predecessor s operations in consolidated F/S from Oct 16, 2011 File separate income statement, cash flows and MD&A for predecessor for Jan 1 Oct 15, 2011 and for 2010 and 2009 (2009 not required for small reporting company)

11 Common accounting comments Business combinations Identifying acquirer for accounting purposes in stock deal Valuation issues Acquisition of assets considered a business Availability of / access to books and records Disclosures

12 Common accounting comments Equity transactions Fair value determination When can valuation of stock issuances vary from trading value? GAAP prohibits large block discounts Thinly traded Restrictions

13 Common accounting comments Embedded conversion options and freestanding warrants Convertible debt if not conventional debt, conversion feature must be bifurcated and marked to market each period Ratchet or down round provisions in convertible debt or warrants create mark to market derivative liabilities Staff may challenge how the instruments are valued

14 Common accounting comments Embedded conversion options and freestanding warrants Other common pitfalls: Cash settlement provisions Registration requirement impact Insufficient authorized shares No limit on number of shares to be delivered

15 Common accounting comments Internal control over financial reporting (ICFR) Effective or not effective (no qualifying language) ICFR can t be effective if a material weakness (MW) exists Robust discussion around MW s Quarterly reporting of changes in ICFR Impact of significant operations outside the U.S. Auditor s responsibility around ICFR disclosures

16 Disclosure controls and procedures (DC&P) ICFR is a subset of DC&P DC&P is effective or not effective (no qualifying language) If DC&P is deemed effective and ICFR is not effective staff will ask for support Auditor responsibility around DC&P disclosures

17 Form 8-K Common accounting comments Item 4.01 Changes in Registrant s Certifying Accountant Item 4.02 Non-reliance on previously issued financial statements or audit report or review within 4 days of knowledge of material misstatement Items 2.01 and Acquisitions or Dispositions and pro forma financials

18 Oil and Gas reserve comments Five-year rule issues: Reserves booked for more than five years remaining undeveloped Reserves scheduled to be developed more than five years hence Mathematically impossible development rates Disclosure of progress toward converting PUD to PDP Disclosure of technologies used in adding material amounts of reserves from year to year

19 Oil and Gas reserve comments Staff may ask for reason why reserves remain undeveloped. (Note one comment even did not accept fact could not get development done due to lack of availability of fracking equipment and completion services said should have been able to anticipate that problem and remove reserves that could not be developed in 5 years)

20 Oil and Gas reserve comments Generic reference to engineering standards Disclosure of technical qualifications of the person primarily responsible for the oversight of reserves preparation Disclosure of internal controls over reserves estimation Disclosure of remaining minimum terms on undeveloped acreage

21 Oil and Gas reserve comments Inconsistencies in average costs per unit incurred historically versus average cost per unit projected in reserves reports Accounting policy disclosure of depletion policy for leasehold versus completed wells (Total proved versus proved developed) Insufficient detail in explanation of changes in reserves (primarily revolves around revisions in previous quantity estimates).

22 Topics covered in December 2011 AICPA SEC conference Tend to be hot button areas over the coming year Loss contingencies Fair value in general and specifically use of third party pricing services (company s and auditor s responsibility) Effect of foreign currency flux Amendments of goodwill impairment testing- new qualitative test

23 Topics covered in December 2011 AICPA SEC conference Income tax disclosures Sovereign debt disclosures Error corrections and reclassifications update of annual financials in registration statement can remove restatement disclosure IFRS issues Non GAAP financial measures

24 Topics covered in December 2011 AICPA SEC conference MD&A Immaterial items and disclosure overload IFRS in relation to foreign operations e.g. qualifications in U.S. GAAP of preparers Consolidations

25 Q&A Wayne Gray Joe Blice