When an issuer files a registration statement or undertakes an offering after its fiscal year-end but before the issuance of its annual audited financial statements, difficulties may arise as to the level of comfort that an issuer's accountant may provide. Registration statements that are filed after a fiscal year-end but before the annual audited financial statements are issued often include or incorporate by reference so-called "capsule financial information" for the fourth quarter and/or the full year. Underwriters will generally request a comfort letter with respect to the capsule information as part of their due diligence procedures. Accountants are often reluctant to provide certain comfort procedures relating to such capsule information, as the financial statements underlying the information have not been issued and the information is therefore subject to change. This article provides guidance for underwriters with respect to comfort letter procedures relating to the financial information included in registration statements prior to the issuance of year-end audited financial statements.
Guidance from the AICPA
The AICPA's Center for Public Company Audit Firms' SEC regulations committee has issued a white paper discussing the various types of comfort letter procedures on capsule financial information that underwriters may request and a discussion of what comfort, if any, that accountants may provide. Such procedures include:
- Negative assurance that the full-year capsule information has been reviewed pursuant to Statement on Auditing Standards No. 100, "Interim Financial Information" ("SAS 100"):
- Accountants are not permitted to provide this information, as SAS 100 applies only to interim financial information.
- Positive assurance that the year-end capsule financial information has been audited:
- Accountants may not comment on the completeness (or the status, other than the fact that the audit is subject to completion) of the audit prior to the issuance of the issuer's financial statements, as the issuer and the auditor are responsible for evaluating post-balance sheet subsequent events for their impact up to the issuance date.
- Negative assurance that the fourth quarter capsule information has been reviewed pursuant to SAS 100:
- After accountants have performed a SAS 100 review, they are permitted to provide negative assurance on the unaudited condensed interim information, provided that they (i) state that the information has not been audited, (ii) state that they cannot express an opinion on the information and (iii) attach the fourth quarter financial statements to the comfort letter if these are not included in the registration statement.
- Accountants should wait until audit fieldwork is "substantially complete" and the year-end financial statements are in "substantially final form" (as determined by the accountant using his/her professional judgment).
- Reading fourth quarter unaudited financial information and reporting certain changes:
- Accountants are permitted to provide negative assurance for the final quarter and that they are unaware of certain changes in the statement amounts.
- should only provide such negative assurance regarding specified changes when audit fieldwork is substantially complete (even if the year-end financial statements are not in substantially final form);
- may require the issuer to publicly disclose fourth quarter information in advance of providing comfort, for example, by filing a Form 8-K with primary financial statements but no footnotes;
- may choose to disclose that they have not completed their audit of the full year statements and that the fourth quarter remains subject to change; and
- may elect to provide comfort on a shorter period within the fourth quarter even if the audit fieldwork is not substantially complete.
- Inquiring of issuer officials as to changes in specified financial statement elements:
- Accountants may provide negative assurance that they have questioned issuer officials and that they are unaware of certain changes in the financial statement elements up to 135 days from the end of the most recent period for which an audit review has been performed.
- should, if the cutoff date is year-end, make inquiries only after the year-end audit fieldwork is substantially complete (even if the year-end financial statements are not in substantially final form); and
- may, if the cutoff date is not year-end, choose to wait until the audit fieldwork is substantially complete or choose to report the results of the inquiries rather than expressing a general negative assurance.
- Agreeing the fourth quarter or full year capsule financial information to the issuer's accounting records ("tickmark" comfort):
- Accountants are permitted to agree unaudited information contained or incorporated by reference in a registration statement to an issuer's accounting records if they have performed an audit of the financial statements for a period including or immediately prior to the unaudited period or if the accountants have otherwise obtained knowledge of the issuer's internal control.
- should agree fourth quarter and full year information only after audit fieldwork is substantially complete (even if the year-end financial statements may not be in substantially final form).
Considerations for Accountants
Although accountants desire to provide comfort letters as a service to their clients, they may reasonably be reluctant to perform certain procedures on capsule financial information when the underlying year-end financial statements have not been issued and are still subject to change. Compounding this issue, the accountant is often engaged to conduct or is in the process of conducting the issuer's year-end audit, which is subject to a higher standard of professional service. Recognizing these factors, accountants are within their rights to exercise caution in providing certain levels of comfort in order to avoid assuming disproportionate risk. Regardless of the type of comfort requested, in coming to any conclusions as to the comfort provided, accountants should consider certain factors relating to the issuer, including the internal control environment, the nature of the business, open contingencies and the issuer's history of audit adjustments.
Considerations for Underwriters
Although accountants are permitted to provide certain comfort as described above, they may be reluctant to do so. This is particularly true recently, with accountants increasingly becoming wary of liability issues in today's heightened regulatory environment. Even when accountants do provide comfort, they rarely provide SAS 100 negative assurance, as the financial statement balances and amounts are subject to change and are subject to ongoing audit procedures. Underwriters must consider the level of comfort the accountants are willing to give in the context of their duties and liabilities in an offering.
Underwriters are liable under Section 11 of the Securities Act of 1933 if "any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading." For "non-expertized" portions of a registration statement, Section 11 provides a defense (the "due diligence defense") if the underwriter can show that it "had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading."
In order to satisfy their due diligence obligations, underwriters are advised to attempt to obtain the AICPA-approved comfort from accountants. To the extent that an accountant is reluctant to give comfort on any particular issue, counsel to the underwriter should discuss the AICPA white paper with the accountant to demonstrate that providing "tickmark comfort" and some level of negative assurances are consistent with the AICPA guidance. Industry standards should also be researched and brought to the attention of the accountant.
To the extent the accountants refuse to provide desired comfort and the underwriter still desires to go forward with the offering, the underwriter should examine risks, conduct thorough internal diligence to ensure that the numbers are correct and keep detailed records of this process. As comfort letters are customary, underwriters must take rigorous internal measures to ensure that they are convinced of the accuracy of the financial information in the registration statement, if proceeding without an accountant's comfort letter. However, if the underwriter does not believe that it can meet the due diligence defense when considering all the facts and circumstances, the offering should be delayed until after the audit is complete. In most circumstances, the most prudent course of action is to delay the offering if the accountant refuses to provide any comfort.
Underwriters must take into account all issues discussed above when considering participation in a post-year-end offering, in order to protect themselves from undue or disproportionate risk.