Are you informed when a company receives a comment letter from the SEC?

Every CFO of a publicly traded company in the U.S. dreads receiving a comment letter from the Security and Exchange Commission (SEC). Period. Although receipt of one is inevitable since, by law, the SEC is required under the Securities Exchange Acts of 1933 and 1934 to review a public company’s filings at least once every three years. The astute CFO can try to stay ahead of the game by analyzing company data during its reporting process in order to proactively avert untimely comments by providing increased clarity in submissions of its financial statement disclosures. And when that inevitable day does come, that same astute data analysis can be used in providing the support needed for a spot-on crystal clear response.

This all sounds great in theory, but is it practical? Is it in the best interest of the company and the shareholders of said company for the CFO to spend finite and valuable resources on data analysis that decreases the risk of something considered par for the course of a public company? We believe the answer is a resounding yes. Preserving shareholder value through cost-effective practices that create efficiency and decrease financial risk is often at the top of the list of the goals of every astute CFO.

For an analyst or investor, does the fact that a company received a SEC comment letter signal reporting issues that you may want to trade on? For some…. Or, so the ‘data’ tell us. An academic study published in 2016, shows that the stock price of a company drops between 1-5% in the 50 days following the date that the comment letter is made public on the EDGAR website.

Anomalies in data that catch the SEC’s attention

So, can we look at the underlying trends in the financial data of companies and see which companies are more likely to receive a comment letter?

Let’s take a look at the effective tax rate analysis for Dolby Laboratories.

You can see from this card that there is a stark difference in the trend between 2014 and 2015, where domestic income dropped, whilst foreign income increased.

Dolby Labs Tax Rates - Line Graph

At the same time, you can see the effective tax rate stays somewhat the same whilst the effective tax rate due to foreign tax rate differential increases significantly. This trend might catch the SEC’s attention since income from foreign operations and its tax implications begin to contribute more significantly to consolidated operations but the company’s overall effective tax rate stays the same.

Dolby Labs Tax Rates - Bar Graph

In the next card, you will see the SEC comment letter received by Dolby Laboratories in 2016 Q1. The SEC sought clarification on Dolby's foreign earnings in lower tax-rate jurisdictions and how this impacted the effective tax rate in 2015.

View Notes - Dolby Labs

Data tell a story and reveal insights

Certain trends in financial data become obvious when you can visualize multiple, related KPIs together. What can we learn from this? If you are a CFO and your effective tax rate reconciling items and their related financial statement line items exhibit similar correlations to Dolby Laboratories, you might also receive a SEC comment letter seeking similar clarifications. If you are an investor seeing similar patterns in the data of other companies and assessing the likelihood of the company receiving a SEC comment letter, you might want to consider adjusting your trading strategy. Based on the findings of the academic study, if you know as soon as a company receives a SEC comment letter, you can get ahead of the market. Sign up here to be notified as soon as a company receives a SEC comment letter and see relevant supporting data.

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