Long SEC Reviews Quarterly Update # 4

Long SEC reviews reflect ongoing regulatory concerns over a company’s financial disclosures or accounting practices, signaling potential risks or uncertainties to investors.

What are unresolved SEC comments, and why are they important?

SEC comment letters refer to issues or concerns the U.S. Securities and Exchange Commission raised during the regulatory review of publicly traded companies' financial reports, particularly in their 10-K and 20-F filings. The routine reviews aim to enhance transparency, accuracy, and compliance in these companies' accounting and disclosure practices.

When the SEC identifies deficiencies or unclear aspects in a company's financial reports, it issues comment letters to request clarification or corrections. Companies are expected to address these comments promptly within ten business days of receiving the comments. The number of comments received, and the time taken to address them (duration) are often used as metrics in academic literature to evaluate the significance of concerns raised by the SEC (Cunnigham and Leidner, 2022). While SEC comments are typically resolved within 40 to 60 days and through one or two rounds of comments, some inquiries remain unresolved for an extended period, sometimes up to a year.

Companies are generally not required to disclose ongoing SEC reviews. However, "Item 1B Unresolved Staff Comments" of 10-K filings requires companies to report unresolved SEC comments issued at least 180 days before the fiscal year-end. This extended duration of unresolved comments could indicate more complex or significant issues that require additional time and effort to rectify (see further discussion of outcomes of unresolved SEC comments here).

Item 1B Unresolved SEC comments – quarterly update # 4 for the quarter ending September 30, 2024

Three companies disclosed unresolved SEC comments during the September 30, 2024, quarter.

Radiant Logistics Inc (Ticker: RLGT) disclosed on September 12, 2024, that on June 4, 2024, the Company received a comment letter from the SEC related to the Company’s disclosure of a cybersecurity incident on an 8-K Item 1.05.

According to the Company’s March 20, 2024, 8-K Item 1.05 filing, while the incident caused a delay in services in Canada, the issue was promptly remediated and, as of the date of the filing, did not have a material impact on the Company’s operations:

“While the incident in combination with the Company’s security protocols have caused service delays for customers in Canada, systems recovery efforts are in process and the Company currently estimates those efforts to be largely complete in the coming week. The Company’s U.S. and other international operations have continued without disruption throughout this process in all material respects.

While the investigation is ongoing, as of the date of this filing, the incident has not had a material impact on the Company’s overall operations, and the Company has not determined the incident is reasonably likely to materially impact the Company's financial conditions or results of operations.”

SEC rules require that companies disclose material cybersecurity incidents within four business days of the event using Item 1.05 of 8-K. Additionally, companies must disclose the impact of the material incidents on the company, including on the company’s results of operations. While companies may voluntarily report immaterial cyber incidents using Item 8.01 of Form 8-K, immaterial breaches and attacks should not be reported on Item 1.05.  

Radiant Logistics reported that the SEC was seeking more clarity about why an incident that is not expected to have a material impact was reported on Item 1.05. Radiant responded that they wanted to be on the safe side, and that the Company’s disclosure is consistent with how other companies reported the incidents:

“We filed a response to the SEC’s comment letter on June 18, 2024, in which we indicated that the Form 8-K was filed out of an abundance of caution based on, among others, the fluidity of a materiality determination while investigation of the cybersecurity incident was ongoing, and review of similar disclosures from other issuers under Item 1.05 of Form 8-K. We are awaiting the SEC's response to our response letter.”

Radiant’s response emphasizes an important point: materiality analysis is subjective, given to interpretation, and may change over time.

Radiant noted in its 10-K disclosure that SEC comments were still outstanding as of the date of the 10-K filing. SEC comments are generally publicly released on EDGAR at least twenty days after the resolution of all comments.

I discussed SEC comments on AT&T’s reporting of the cybersecurity incident in my previous post. Suppose SEC comments to AT&T and Radiant are an early indicator of an emerging trend. In that case, we are likely to see more SEC inquiries around two aspects of Item 1.05 disclosure – namely, the materiality determination and proper disclosure of the overall impact of cyber incidents. Note also that companies must use both qualitative and quantitative criteria when accessing the materiality of cyber incidents.

Let’s look at the disclosure of the other two companies with Unresolved SEC Comments. United Express Inc (Ticker: UNXP) disclosed on September 30, 2024, that the SEC was inquiring about whether the Company’s acquisition of  the Fighting Leagues assets was properly accounted for as a business combination. The company reevaluated the accounting treatment following the SEC’s comments and restated the financial statements  - see the original and amended 8-K Item 4.02 filings.

Notably, the Company’s auditor Yusufali & Associates LLC, notified the PCAOB that the firm is withdrawing its registration with the regulator. Public companies are required to use a PCAOB-registered firm to audit financial statements included in SEC filings. A withdrawal of the PCAOB registration means that UNXP will have to find a new auditor, which may prove challenging in today’s tight audit market.

In my opinion, when an audit firm steps down – for any reason – it’s in the company’s best interest to start searching for a replacement as soon as possible. Interestingly, Nicola White of Bloomberg reported, citing some of Yusufali’s clients, that some of the clients may not be aware of the pending audit firm’s deregistration threat:

“The offering documents filed with the SEC Wednesday include a sign-off from its auditor, New Jersey-based Yusufali & Associates LLC. That audit firm has recently petitioned the US audit regulator to withdraw its public company auditor registration status, meaning it could soon no longer vet the books of public companies.

Lottery.com said it has not been informed by the firm of its plans to withdraw. If it receives a notification, the company will look for a new auditor.”

(List of clients for which Yusufali & Associates LLC signed an audit opinion is available on the PCAOB site.)

Finally, the third company with the Unresolved SEC Comments disclosure, Greenway Technologies Inc (Ticker: GWTI), disclosed on July 16, 2024, that in August 2023 the SEC requested that the Company amends its conclusion of Disclosure Control and Procedures to ineffective. The Company agreed to comply in future filings. SEC comments were publicly disseminated on EDGAR on October 13, 2023.

Longest SEC reviews and limitations of Item 1B Unresolved SEC Comments requirements

Item 1B disclosure is important because it alerts investors about material outstanding issues raised by the regulators while the review is ongoing and before SEC comments are publicly released on EDGAR. Yet, Item 1B has several limitations:

• Companies are required to disclose unresolved SEC comments that were outstanding at least 180 days prior to the fiscal year-end. Suppose SEC comments were issued to a company with a calendar year-end in mid-July and were still outstanding as of the 10K date. The disclosure is not required in this case because the comments were outstanding for less than 180 days.  

• The disclosure is not required if the comments were resolved before the 10-K filing date—even if they were outstanding for more than 180 days at the fiscal year end.

• Smaller reporting companies - as defined by Rule 12b-2 of the Exchange Act of 1934 - are not required to provide Item 1B disclosure.

(A memo by Latham & Watkins provides a more detailed overview of the regulatory requirements.)

Long comment letter conversations point to a disagreement between the company and the SEC about accounting treatment or disclosure, sometimes leading to a restatement of financial statements. Even if a company succeeds in convincing the SEC that the accounting treatment is appropriate, these comment letters are worth reading because they may flag material issues and provide incremental information about the impact of the issues on important accounting or business metrics.

The table below describes SEC comment letter conversations that have lasted at least 180 days (“long conversations”) and have been publicly released on EDGAR between July and September of 2024.