SEC Comment Letter Trends

During the 12 months ended June 30, 2022, the first and second most common comment areas by the SEC were non-GAAP financial measures (also number 1 in 2021 and 2020), followed by management’s discussion and analysis of financial condition and results of operations (“MD&A”) (also number 2 in 2021 and 2020).² In fact, within the top 5 areas of comment, there was no movement with segment reporting, revenue recognition and fair value measurements being the number 3, 4 and 5 areas of comment, respectively.³ Within the remaining top 10 areas of comment, notable changes included climate change disclosures making the list as the number 6 most frequently commented on topic and acquisitions and business combinations making the list as the number 10 most frequently commented on topic.⁴ According to Ernst & Young, contingencies and income taxes dropped out of the top 10 commented topics.⁵

According to Ernst & Young, the SEC Staff’s comments on climate change disclosures are aligned with the SEC’s Sample Letter to Companies Regarding Climate Change Disclosures (the “Sample Letter”),⁶ which builds on the SEC’s last significant guidance on climate change disclosure first published in its February 2010 Guidance Regarding Disclosure Relating to Climate Change (the “Guidance”).

In the Sample Letter, the SEC Staff reminds issuers that depending on their particular facts and circumstances, climate change disclosure could be required in the issuer's description of business, legal proceedings, risk factors, and MD&A. Disclosure topics suggested in the Guidance include:

• the impact of pending or existing climate change-related legislation, regulations, and international accords;
• the indirect consequences of climate change-related regulation on business trends;
• the physical impacts of climate change; and
• quantitative and qualitative discussion about potential material capital expenditures for climate change-related projects.

Importantly, in all cases, an issuer must disclose such further material information, if any, as may be necessary to make the required disclosures, in light of the circumstances under which they are made, not misleading.

As more and more companies prepare and publish extensive reports covering a variety of environmental, social and governance (“ESG”) matters (sometimes titled “sustainability” reports), issuers should consider that the SEC Staff may review these reports and compare the disclosure in the sustainability report to the climate-related disclosures in the issuer’s SEC filings. Ernst & Young cited the following sample comment: “We note you provided more extensive disclosure in your [sustainability] report than you provided in your SEC filings. Please advise us what consideration you gave to providing the same type of climate-related disclosure in your SEC filings as you provided in your [sustainability] report.”⁷ Ernst & Young further observed that climate-related comments often resulted in multiple rounds of letters⁸ suggesting the SEC Staff was not satisfied with some issuers’ initial responses.

With respect to comments about acquisitions and business combinations, Ernst & Young noted that SEC Staff comments often inquire about pro forma and similar disclosures required by the Accounting Standards Codification as well as Rule 3-05 and Article 11 of Regulation S-X (“significant” acquisitions), including materiality determinations where certain disclosures are not presented.⁹

SEC Loss Contingency Enforcement Action

On September 9, 2022, the SEC filed a complaint against three former officers of SPYR, Inc. (“Spyr”) alleging the officers lied to auditors about the existence of a pending SEC investigation and failed to properly account for the investigation as a loss contingency in Spyr’s financial statements filed with the SEC. The SEC’s investigation began in 2014 and culminated with the SEC filing a civil action on June 18, 2018 against Spyr, its chairman and a related entity. Importantly, on April 5, 2017 the SEC’s Division of Enforcement sent a “Wells Letter” to Spyr notifying Spyr that it intended to recommend that the SEC charge Spyr with violating the securities laws. From this date and continuing through January 26, 2018, the SEC and Spyr engaged in settlement discussions and correspondence. During these discussions, the SEC Staff indicated that the Staff would be seeking a penalty between $11 million and $13 million, which the Spyr acknowledged could have “killed the Company given its poor financial condition.”

After hiring a new auditor to audit Spyr’s December 31, 2017 financial statements, Spyr never disclosed the existence of the SEC’s ongoing investigation, despite receiving the Wells Letter and the ongoing settlement discussions. In connection with the filing of Spyr’s Form 10-K for the year ended December 31, 2017, two of the charged officers signed an audit inquiry request from the auditor representing that there had been no “communications from the SEC or other regulatory agencies regarding the Company” and there had been no “violations or possible violations of laws or regulations.”

In addition to the being charged with lying to the auditors¹⁰, the SEC alleges that the officers knowingly failed to file financial statements prepared in accordance with GAAP. The SEC alleges in its complaint that the charged officers never conducted a good faith assessment as to whether the pending enforcement action needed to be disclosed. The SEC stated that “no reasonable officer or director would not have disclosed a loss contingency when they were aware of the potential changes and penalties against Spyr, that settlement negotiations had broken down, that any penalty paid by the Company would be material, and that the SEC’s Enforcement action was likely coming soon.”¹¹

²See Ernst & Young LLP, SEC Reporting Update, Highlights of trends in 2022 SEC comment letters (Sept. 8, 2022).

³See id.

⁴See id.

⁵See id.

⁶See id.

⁷See id.

⁸See id.

⁹See id.

¹⁰The SEC additionally charged the officers with making similar misrepresentations to the predecessor auditor for a number of periods while the investigation was ongoing

¹¹The SEC cited an internal a text message string among some of the charged officers stating, “with the SEC complaint only days/weeks from being served . . . we really need to get this 10-K [for the year ended December 31, 2017] filed ASAP.”