Regulatory Oversight of Financial Reporting: Securities and Exchange Commission Comment Letters

Abstract

The Securities and Exchange Commission (SEC) reviews company filings (10-Q, 10-K, S-1, etc.) submitted to them. If a review identifies potential deficiencies, the SEC staff sends the company a comment letter seeking clarification, additional information, and ultimately, perhaps, revision of the filing or future filings. We examine the content, resolution, and ensuing informational consequences of SEC comment letters. The content analysis shows that nearly half of all comments involve accounting application, financial reporting, and disclosure issues. More than 17 percent of our sample cases result in immediate amended filings to resolve the issue(s) arising from the comment letters, and financial statements and/or footnotes are frequently revised. Following comment letter resolution, the adverse selection component of the bid-ask spread declines and Earnings Response Coefficients (ERCs) increase. Our results provide little support for the conjecture that the market interprets the receipt of a comment letter as a signal that the firm has poor reporting quality. Finally, we find no evidence that comment letter firms increase the quantity or change the type of voluntary disclosure, thereby eliminating a possible competing explanation for the improved information environment. We conclude the SEC's oversight has beneficial informational effects. Surveillance r eglementaire de l'information financi ere : les lettres d'observations de la SEC r esoudre la ou les questions soulev ees dans les lettres d'observations, et les etats financiers et (ou) les notes font fr equemment l'objet d'une r evision. A la suite de la r esolution des questions soulev ees dans les lettres d'observations, la composante d'antis election de l' ecart acheteur-vendeur d ecline et les coefficients de r eaction aux r esultats augmentent. L' etude livre peu d'indications confirmant l'hypoth ese selon laquelle le march e interpr eterait la r eception d'une lettre d'observations comme un signal de la pi etre qualit e de l'information fournie par la soci et e. Enfin, les auteurs ne rel event aucun el ement qui confirmerait que les soci et es recevant des lettres d'observations augmentent le volume d'information facultative qu'elles publient ou en modifient la nature, ce qui elimine la possibilit e d'invoquer une autre explication : celle d'un meilleur environnement d'information. Les auteurs concluent que la surveillance de la SEC a des r epercussions b en efiques sur l'information.

The Spillover Effect of SEC Comment Letters on Qualitative Corporate Disclosure: Evidence from the Risk Factor Disclosure

“…In 2005, the SEC started to release comment letters resulting from its reviews, suggesting that the SEC considers its review process a powerful enforcement tool. With the availability of these letters, a new stream of research has formed to examine the determinants of receiving comment letters and the effects (or lack of effects) of comment letters on commented firms (Cassell et al ; Robinson et al ; Johnston and Petacchi ). We extend this literature by examining the effects of SEC comment letters on non‐commented firms.…”

How Busyness Influences SEC Compliance Activities: Evidence from the Filing Review Process and Comment Letters

“…Prior literature finds that firm size and age are positively associated with the receipt of a comment letter (Cassell et al 2013;Johnston and Petacchi 2017). Therefore, we expect a positive coefficient on logMV and FirmAge.…”

“…Previous studies also find that comment letters influence a firm's information environment and have capital market consequences. For example, Johnston and Petacchi (2017) report that comment letters improve firms' information environment, and Dechow et al (2016) find a negative market reaction and increased insider sales around the announcement of 10-K comment letters related to revenue recognition. Given the potential for workload compression to adversely affect SEC compliance activities and 1 We use the terms SEC, ADO, and Corp Fin interchangeably.…”

Unexpected SEC Resource Constraints and Comment Letter Quality

“…Johnston and Petacchi () find that ERCs increase after the resolution of a comment letter, suggesting that comment letters affect the market's perception of earnings quality. To the extent spike comment letters are not as effective in improving earnings quality as letters issued during dip periods, we expect ERCs after the resolution of spike comment letters to be lower compared to dip letters.…”

“…Prior literature finds that the resolution of comment letters for periodic reports is associated with reduced information asymmetry and improved earnings quality (Bozanic et al ; Johnston and Petacchi ). Therefore, we next explore whether there are related economic consequences of comment letters issued during periods of unexpected SEC resource constraints.…”