SEC Expands JOBS Act Registration Filing Provisions to All Companies

By Charles Soranno, Managing Director
Financial Reporting Compliance and Internal Audit

 

 

Good news for companies that are planning or considering an initial public offering (IPO): The confidential IPO review period, created in 2012 to assist emerging growth companies, is now available to any company considering a public offering, regardless of size. The June decision by the U.S. Securities and Exchange Commission (SEC), effective July 10, 2017, is the first major policy move by new SEC chairman Walter J. Clayton.

Prior to July 10, only smaller companies (defined as those with less than $1.07 billion in annual revenue) were allowed to confidentially file draft registration statements for SEC review before their public offerings. The Jumpstart Our Business Start-Ups (JOBS) Act was created to stimulate the economy by making it easier for these so-called “emerging growth” companies to expand through IPOs. The confidential review period was intended to protect sensitive information required under SEC registration requirements from the competitive threat of premature public scrutiny and to allow companies to consider other exit options at the same time as pursuing an IPO.

There has been some debate as to whether the limited confidentiality period — which expires 15 days prior to the effective date of the public offering — is an effective incentive. Some analysts have also complained that the provision shortens the time they have to perform their own due diligence before a stock hits the market. The SEC, however, says that allowing companies to handle IPO preliminaries in secrecy provides companies more time to plan their offerings and protects them from market fluctuations that can adversely affect companies at a vulnerable time, as well as allows them multiple exit options. The SEC provided these answers for submitting draft registrations under the new rules.

Although the impact of the SEC’s action has yet to be determined, generally speaking, the extension of the confidential review process seems like a great opportunity for companies looking for some kind of exit. As to whether it will succeed in its stated goal, that will depend on a number of factors, including economic conditions, sector timing, industry attractiveness and the individual company’s value proposition.

With all this said, it is also important to note that the extension of confidentially does not change the substance of what pre-public companies have to do to prepare for an IPO. Planning to become a public company is time-consuming and complex, whether done in confidentiality or not. Much of that complexity is due to the numerous legal and technical requirements that must be addressed prior to an IPO. But a substantial — and often overlooked — aspect of public company readiness involves transforming organizational functions and processes.

Protiviti’s Guide to Public Company Transformation, 3rd Edition is an excellent resource for any company that wishes to review the key steps to achieving public company readiness. For starters, our guide recommends that companies establish a baseline of policies and procedures and develop a plan for bringing those critical elements in line with the heightened expectations for a public company. Specifically, our guide recommends that companies:

  • Develop a baseline of appropriate accounting, operational and regulatory policies and procedures
  • Take stock of the maturity of key processes
  • Develop a baseline for the financial close and forecasting capabilities
  • Address skills gap and other organizational changes
  • Perform a risk assessment and initial scoping for Sarbanes-Oxley readiness and compliance
  • Assess the IT environment and consider the specifications of the right ERP system (if required)
  • Establish a program management office to address incremental work streams and competing initiatives

This checklist just scratches the surface. For a more substantive analysis download the guide, or register to watch the archived version of our webinar, “It’s What You Don’t Know That Can Affect Your IPO.”

At the end of the day, while this move by the SEC is good news, there’s still a lot of work that companies have to do to prepare for an IPO. The links above should provide a good starting point.

Health Check on Emerging Growth Companies: PCAOB Reports High Incidence of Material Weaknesses

By Charles Soranno, Managing Director
Financial Reporting Compliance and Internal Audit

 

 

 

A new white paper from the Public Company Accounting Oversight Board (PCAOB) and an April increase in qualifying revenue limits have put emerging growth companies (EGCs) in the news recently.

The EGC designation, established under the Jumpstart Our Business Startups (JOBS) Act of 2012, makes it easier for small and growing businesses — specifically those on track for an initial public offering — to attract investors and access capital by relaxing regulatory requirements and cutting some red tape. There are a number of benefits to a registrant being classified as an EGC – see Protiviti’s Guide to Public Company Transformation for what they are.

The original law established a revenue cap of $1 billion for a company to qualify as an EGC, but provided for that cap to be adjusted every five years for inflation. The Securities and Exchange Commission (SEC) made the first adjustment in April 2017, raising the revenue cap to $1.07 billion.

Another provision of the JOBS act was a mandate for the PCAOB to report via white papers, semiannually, on the extent to which EGCs actually benefitted from regulatory relief, and any unintended consequences stemming from the more permissive environment. The purpose of the PCAOB’s white papers is to provide general data about EGCs to inform the analysis contained in PCAOB rulemaking releases regarding the impact of applying new standards to the audits of EGCs.

The latest white paper, published in March 2017, found that of 1,951 companies reporting as EGCs in the 18 months prior to the reporting period, more than half (51 percent), received an explanatory paragraph in their most recent auditor’s report expressing substantial doubt about the company’s ability to continue as a going concern. Equally important, within that group of 1,951 EGC filers, 1,262 provided a management report on internal control over financial reporting in their most recent annual filing, and 47 percent – nearly one-half of all EGC filers – reported material weaknesses.

Protiviti explores the findings in the PCAOB’s March white paper at length in a recent Flash Report, but I wanted to highlight a few of the takeaways here.

First and foremost, while certain regulatory exemptions and benefits may be attractive, they do not mean that EGCs should accept or minimize issues surrounding potential findings of material weaknesses. These deficiencies in internal control over financial reporting may undermine a company’s reputation and reduce company value, to say the least.

The risk is real and should be addressed proactively. Protiviti has developed a financial reporting risk profile (FRRP) to identify financial reporting issues in advance and manage them to avoid potential financial restatements.

An effective FRRP focuses on six areas: accounting principle selection and application, estimation processes, related-party transactions, business transaction and data variability, sensitivity analysis, and measurement and planning. The underlying objective is to identify the most likely areas of potential misstatements and apply the appropriate oversight and control.

Second, EGCs should take the steps necessary to document key business processes so that these processes are well-defined and repeatable, reducing reliance on ad hoc activity by key employees. These processes may include a fair amount of financial reporting; related policies and activities, such as those that aid in the preparation of financial schedules for external auditors in the support of audits; filings; executive compensation; and employee benefits. Pre-public companies should design and implement a process for documenting conclusions on reporting and accounting matters.

Internal controls and documentation are critical because they minimize the risk of material weaknesses in the organization’s financial reporting. Consider the effects of just one material weakness: erosion of shareholder confidence, potential share price reduction, a fair amount of distraction throughout the organization, reduced brand quality, and significant remediation costs.

The high incidence of material weaknesses among EGCs is disappointing but, in many cases, generally preventable. It is important not to wait until the first auditor attestation to address potential issues. Many of the preventive measures – governance protocols, fraud controls, internal controls over financial reporting – should be in place prior to the company’s first public filing (e.g., 10Q filings, 302/906 certifications), and others should be in place prior to the initial management assertion on the effectiveness of internal control over financial reporting, as required by Sarbanes-Oxley Section 404(a). If these areas have not been addressed and the first public filing is upcoming, the organization should prepare itself by putting in place a robust remediation program. See the Protiviti Flash Report for additional points and information.