During the recently completed filing season for calendar year-end Smaller Reporting Companies I frequently provide suggestions for improving the overall quality of the Form 10-K. This generally includes suggestions to eliminate redundancy; provide concise and specific disclosures; provide useful analysis of historical results; and provide reasonable expectations related to future near term trends, commitments, liquidity, and other known material events and transactions. These suggestions not only affect the financial statements, but they generally apply to other significant areas such as business overview, risk factors, and management’s discussion and analysis.
In my experience, issuers tend to rely on their attorneys for guidance on the non-financial statement portions of the Form 10-K. Most attorneys that I have dealt with focus only on standard regulation compliance and lawsuit prevention. While these things are obviously important, they generally do not improve the quality of the disclosures. To be fair, most attorneys are not asked to help make improvements in order for issuers to somewhat manage attorney fees.
The SEC’s Corp Fin Staff recently published Staff Observations in the Review of Smaller Reporting Company IPOs at www.sec.gov/divisions/corpfin/guidance/cfsmallcompanyregistration.htm which provides a brief reminder for quality improvement and avoiding the comment process. While these observations specifically relate to registration statements they are also applicable to Forms 10-Q and 10-K.
Some highlights:
Risk Factors – “Generic risk factor discussions that do not describe how a specific risk applies to the company or an investment are not helpful to understanding the risk. Also, it is rarely helpful to state there can be no assurance of a particular outcome”
Description of Business – Reg. S-K requires a description of a company’s business development over the last three years and provides an overview of the material aspects of the business. Further, “Where it was not clear what a company did to generate revenue or what its future growth strategy was, we (Corp Fin Staff) asked it to provide a discussion of its current or intended material sources of revenue”. My experience is that several issuers focus on historical reverse merger and similar capitalization transactions while ignoring the current and near term future functional activities.
Management’s Discussion & Analysis – Financial based discussion should focus on “Any known material trends, demands, commitments, events, or uncertainties that will have, or are reasonable likely to have, a material impact on the company’s financial condition; short-term or long-term liquidity; and revenue or income from continuing operations”. They further state this section should disclose “The past and future financial condition and results of operations of the company, with particular emphasis on the prospects of the future”. I don’t believe that providing a narrative of the financial statements, by itself, meets the requirements of Item 303 of Reg S-K or provide any additional useful information. The SEC’s observations indicate results of operations should “Disclose the reasons underlying the causes for the period to period changes”.
Financial Statements; Revenue Recognition – The SEC observations generally recommend an issuer’s revenue recognition policy discloses the “application of specific authoritative revenue recognition guidance for transactions within the scope of the appropriate GAAP literature; the nature and type of earned revenue; and separate revenue recognition policies for each type of earned revenue”. I don’t think cutting and pasting the SAB 104 requirements or GAAP literature on its own meets these observations.
I realize compliance document improvement is probably not on the top of most Smaller Reporting Company’s priority list in today’s environment, but there is definite value in avoiding the SEC comment process. Also, a Smaller Reporting Company’s SEC filings, to a certain extent, serve as the public face of the company and should reflect the high degree of professionalism the boards, officers, and employees of these companies possess.