Drafting the S-1: Avoiding Common Pitfalls in the ... - FTI Consulting

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3. Office of the Chief Accountant (OCA) – A standalone office within the SEC that advises on accounting and auditing concerns associated with interpretive or complex questions on specific accounting standards. Correspondence often happens prior to the filing of the S-1 to ensure no restatement of financial statements occurs. Below is a summary of common issues and causes for communication with the three primary SEC groups: SEC GROUP ISSUE DESCRIPTION DCAO DCAO DCAO AD Groups OCA OCA OCA Predecessor Financial Statements Significant Business Acquisition and Significant Subsidiary Rules Separate Financial Statements of Guarantors Comment Letter Transfer of Assets under Common Control Compensation Arrangements Revenue Recognition The availability of or difficulty in preparing financial statements in situations where a new legal entity structure is employed by the soon-to-be Registrant. The financial statements must show the financial results of the Registrant as if it had existed in prior periods. The availability of or difficulty in preparing separate financial statements for business acquisitions or equity method investments of the Registrant. This often includes challenges associated with access to financial information controlled by third parties. The availability of or difficulty in preparing full financial statements for all entities that guarantee the debt of the Registrant. Issues, comments or questions posed by the AD Group specific to the Registrant’s Form S-1. Pre-clearance related to situations where a new legal entity is created for the IPO, and assets and liabilities must be transferred to the new IPO entity. This often is a significant issue for real estate companies. Accounting issues related to complex compensation arrangements, particularly arrangements that vest upon completion of the IPO. Accounting issues related to new or complex types of business transactions that may require new interpretation of existing revenue recognition guidance. This often is an issue for companies with new technologies or unconventional business models. FINANCIAL INFORMATION AND MD&A: A SPOTLIGHT ON ACCOUNTING For many companies, the financial tables and Management’s Discussion and Analysis (MD&A) will attract the most investor attention, as investors are able to see the financial results for the IPO company for first time. Perhaps more important, this section will be scrutinized very closely by the SEC. In Groupon’s case, the SEC forced the company to revise its accounting policies, which significantly impacted its reported revenues. After the IPO, Groupon had to restate its financial results due to accounting issues. These missteps led to ongoing inquiries by the SEC, shareholder lawsuits and, ultimately, a decline in Groupon’s stock price. The online gamer Zynga also ran into issues affecting investor confidence leading up to its IPO by creating new accounting metrics and revising another. Therefore, it is imperative that a company provide accurate and SEC-compliant information early in the process. DRAFTING THE S-1 3
Given the importance of this section, the MD&A needs to be started earlier than any other part of the S-1. As the company interacts with the SEC on potential accounting issues prior to filing, the S-1 can be adapted accordingly. The company’s audit partner and outside counsel should review all aspects of this section. Some common issues that may complicate the drafting process include international reporting impacts, new metrics and refreshed financial data on a quarterly basis. While the accounting team is responsible for drafting the financial tables and the MD&A, the legal team and PMO should remain involved in the process, ensuring coordination among all the teams and external advisors. The number of risk factors to include varies by company and industry, but the list often spans several pages THE BUSINESS SECTION: TELLING THE STORY The business section of the S-1, which requires a description of the company’s business and operations, can be the most time-consuming section to draft. It requires strategic input from investor relations, corporate strategy and communications/marketing to develop a prospectus consistent with the company’s strategic plan. If the strategic plan is not thorough or up to date, company executives likely will need to actively provide direction on the messaging. While it may be tempting to incorporate existing marketing materials or messaging, writers must be objective and take care to exclude any statements believed to be factual that cannot be substantiated. Underwriters can assist with finding the appropriate balance. Further, the underwriters can use their expertise of the industry to help highlight a company’s competitive strengths and provide an industry overview. RISK FACTORS: HOW MUCH IS TOO MUCH The SEC requires the Registrant to provide investors with a list of potential risks associated with the offering. The number of risk factors to include varies by company and industry, but the list often spans several pages. The challenge lies in providing enough information for investors to consider all reasonable risks without overwhelming investors and raising false alarms. The first step in drafting this section is to review the risk factors included in peer company filings. Many companies, regardless of industry, share similar risks, and these frequently can be adapted by another company. Then the legal team should consult with various operating areas within the business to understand what risks they each face. Input also should be sought from the internal audit team, external auditors and outside counsel. EXECUTIVE COMPENSATION: AVOIDING SURPRISES Upon filing the S-1, executive compensation details will be available to the public. In the time leading up to the IPO, the company will want the public to be talking about the business’ attractive growth prospects, not the potentially distracting aspects of executive compensation. Further, the SEC will be reviewing the compensation section to ensure the appropriate disclosure of executive compensation details. With the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, a number of provisions were adopted by the SEC in January 2011 concerning shareholder approval of executive compensation and “golden parachute” executive compensation arrangements. In June 2012, the SEC adopted rules requiring independence among each member of a company’s compensation committee. Overall, executive compensation has become a hot-button issue in Washington and as a result, is receiving greater focus and scrutiny by the SEC. DRAFTING THE S-1 4
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Drafting the S-1: Avoiding Common Pitfalls in the ... - FTI Consulting

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