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:
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.