SEC Comment Letters: How the Response Process Works and What the Audit File Needs

A comment letter from the SEC staff is routine for a registrant and unfamiliar to many CPA firms. When it arrives, the issuer's accounting team drafts the response, the audit committee watches, and the auditor is asked whether it agrees with the position. If the firm has not worked with the process before, the first letter can feel like a surprise audit. It is better understood as a structured dialogue with a fixed sequence and a public record at the end.

Who reviews and what gets reviewed

The Division of Corporation Finance reviews filings under the Securities Act and the Exchange Act. That includes transactional filings when a company intends to issue securities in a registered offering such as an IPO, and ongoing reports such as annual, quarterly and current reports. Staff may also review Regulation A filings. The Division assigns filings by companies in a particular industry to one of nine industry offices, whose staff have specialized industry, accounting and disclosure review expertise.

Review is selective, and the Division does not publish its selection criteria. The staff's page on the process states that under the Sarbanes-Oxley Act the Division undertakes some level of review of each reporting company at least once every three years, and reviews a significant number of companies more often. Many reviews finish with no comments at all.

The review is about disclosure. The staff does not evaluate the merits of a transaction, and responsibility for accurate disclosure stays with the company. A completed review does not mean the filing is complete and accurate.

Levels of review

The staff describes three levels:

• Full review. A cover-to-cover review of the entire filing.
• Financial statement review. The financial statements and related disclosure, including MD&A.
• Targeted issue review. One or more specific disclosure items.

For an auditor, the financial statement review is the one that lands in the audit file. The questions concern recognition, measurement, classification and disclosure, and the staff expects answers grounded in the applicable accounting standard.

What a comment can ask for

Staff comments may ask a company to provide supplemental information so the staff can understand the disclosure, revise disclosure, add disclosure, or provide additional or different disclosure in future filings. Staff usually issues comments in writing. Each comment letter gives the names and phone numbers of the staff members involved in the review.

The response sequence

1. Read and assign. Number each comment and assign an owner: accounting, legal, investor relations, or the auditor for matters that touch the audit.
2. Seek clarification early. The staff encourages companies to communicate throughout the process, especially to seek clarification. If a comment is unclear, ask the examiner. If it is still unclear, speak with the staff member who approved it.
3. Respond in writing, on time. Companies are expected to respond in a timely manner, and the staff may grant reasonable extensions when warranted. Ask before the date, not after.
4. Amend where appropriate. A response letter explains the position and, if appropriate, the company amends the filing. Sometimes a clear explanation resolves the comment without an amendment, though the staff may follow up.
5. Escalate if needed. A request for reconsideration of a comment, or of the staff's view of a response, goes to the Chief of the reviewing office. The staff's page says no formal protocol is required. The Office of the Chief Accountant handles questions about GAAP and may be involved at any stage of the review.
6. Closing. For a Securities Act registration statement, the Division gives public notice on EDGAR that the statement is effective. For Exchange Act registration statements, periodic and current reports and preliminary proxy statements, the staff sends a letter confirming the review is complete. Neither is a guarantee that the disclosure is complete and accurate.

The record becomes public

The Division posts comment letters and company responses on EDGAR no sooner than 20 business days after it completes its review or declares a registration statement effective. A response letter is therefore written for two audiences: the staff now and every investor, competitor and plaintiff later. Anything the response says about the audit, such as "our auditor concurred," is public.

Worked example

Lakeshore Devices, a registrant with a December year-end, files its Form 10-K. A financial statement review follows. An illustrative comment asks the company to explain how it concluded that a multi-element contract with hardware, installation and a three-year software term contains separate performance obligations, and to tell the staff how it allocated the transaction price.

The accounting team's draft response walks through the contract terms and the allocation. The audit manager does three things before the response goes out.

1. Pulls the file's revenue memo and the contract sample the firm tested, and checks that every fact in the draft agrees with what the firm saw.
2. Checks that the response does not describe audit procedures that the file does not support. If the draft says the auditor tested every contract, the file must show that.
3. Reads the response against the disclosure the company proposes to revise, so that the proposed note and the audited note match.

The partner is asked by the audit committee whether the firm agrees with the accounting. The answer is recorded in a memo, since any later statement in the company's letter that the auditor was consulted ties to it.

What the audit file should hold

• A log of every comment, the owner, the response date and the filing amendment, if any.
• The firm's position on each accounting comment, with the standard it rests on.
• A tie-out of facts in the response letter to the audit evidence.
• A record of what was said to the audit committee and when.
• If a comment points to a possible error in an issued period, a separate evaluation of whether Form 8-K Item 4.02 applies. See Form 8-K Items 4.01 and 4.02.

Common failures

• Responding to the words of the comment and not its concern. If the staff asks how a conclusion was reached, a list of the guidance cited does not answer it.
• Missing a promise made in the response. A commitment to revise future filings is a commitment to a later filing, and it should be calendared.
• Letting the response describe the audit. Describe the company's process, and leave the audit to the audit report.

Related reading

The 10-K disclosure checklist helps pre-empt common comments, and the SEC forms touchpoints page shows where each form meets the audit.

Where CORAA fits

CORAA prepares ready-to-review audit files for US CPA firms. It builds the indexed support that lets a firm trace a response letter to the evidence. The firm keeps the client, the review and the signature. See /us.

Sources

• SEC, Division of Corporation Finance, Filing Review Process: https://www.sec.gov/about/divisions-offices/division-corporation-finance/filing-review-process-corp-fin
• SEC, Office of the Advocate for Small Business Capital Formation, SEC Filing Review Process: https://www.sec.gov/files/filing-review-bb.pdf

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error