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Auditor Attendance At Due Diligence Meetings With Underwriters
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Notice to Readers Underwriters sometimes request to meet with a company’s independent auditor as part of the underwriters’ due diligence procedures in connection with a proposed securities offering. This paper addresses considerations concerning the auditor’s attendance at a due diligence (or similar) meeting with underwriters, and the relevant guidance under the auditing, attestation and other standards for responding to a variety of potential inquiries from the underwriters. This paper was developed by, and reflects the views of, a task force of the Center for Public Company Audit Firms’ SEC Regulations Committee. It provides knowledgeable individuals with a framework, based on professional standards in effect as of July 31, 2005, to consider concerning the auditor’s attendance at such meetings and guidance regarding responding to inquiries. However, caution and individual judgment, based on facts and circumstances, should be exercised by the auditor when considering these matters. The PCAOB is the regulatory body authorized to establish audit and attestation standards for registered public accounting firms in the preparation and issuance of audit reports as required by the Sarbanes-Oxley Act of 2002. This framework has not been approved, disapproved, or otherwise acted upon by the PCAOB or its staff.
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Issue In conducting due diligence, underwriters1, or their equivalent in non-registered offerings, often request to meet with the prospective issuer’s independent auditors, either in person or by teleconference or other means. In many cases, the subject matter of the due diligence inquiries goes beyond the information that would be addressed in a comfort letter issued under Statement on Auditing Standards (“SAS”) No. 72, Letters for Underwriters and Certain Other Requesting Parties, as amended by SAS No. 76 and SAS No. 86 (collectively, “AU 634”). With increasing frequency, underwriters, or their legal counsel, are presenting the independent auditors with an extensive list of questions as part of their “accounting due diligence.” In some cases, the questions would call for the auditor to make subjective and qualitative assessments of the company’s accounting policies and the underlying accounting estimates, its internal control over financial reporting, and/or the capabilities of financial management and members of the audit committee. In other cases, the questions would call for the auditors to divulge information that has been provided to management or the audit committee in reports issued under current auditing standards (e.g., SAS 60 and 61, as amended), which require the auditor to restrict the reports’ distribution and use. In still other cases, the questions request the auditors to address specific elements of the company’s financial statements or matters that are outside of the competence and experience of the auditor. Further, underwriters often request to meet with independent auditors privately (i.e., without the prospective issuer’s management present). This paper addresses considerations concerning the auditor’s attendance at a due diligence (or similar) meeting with underwriters, and the relevant guidance under the auditing, attestation and other standards for responding to a variety of potential inquiries from the underwriters. Background Section 11 of the Securities Act of 1933 (the “Act”) provides that underwriters could be liable if any part of a registration statement contains material omissions or misstatements. Specifically, Section 11(a) of the Act provides (in part) that every underwriter with respect to a security may be sued by any person acquiring that security if any part of the registration statement contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading.
1
Throughout this paper, the plural term “underwriters” is used to indicate a common situation where more than one underwriter, or an underwriting syndicate, may be involved in a securities offering. However, the singular version “underwriter” would equally apply to any situation where only a single underwriter is involved in the proposed securities offering.
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Section 11(b)(3) of the Act, however, provides that the underwriter would not be liable if he sustains “the burden of proof that (among other things)…: (A) as regards any part of the registration statement not purporting to be made on the authority of an expert …he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading;… (C) as regards any part of the registration statement purporting to be made on the authority of an expert … he had no reasonable ground to believe and did not believe, at the time such part of the registration statement became effective, that the statements therein were untrue or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or that such part of the registration statement did not fairly represent the statement of the expert …” Section 11(c) of the Act provides that the standard of reasonableness for purposes of determining what constitutes a reasonable investigation and a reasonable ground for belief under Section 11(b)(3) “…shall be that required of a prudent man in the management of his own property.” This is commonly referred to as the “due diligence” defense. Similar liabilities may exist in securities offerings that are not registered with the SEC. To the extent applicable, the use of the term “underwriters” throughout this paper also applies to “broker-dealers or other financial intermediaries” (often referred to as an “other requesting party”) to whom an auditor may issue a comfort letter in certain circumstances under AU 634. Underwriters generally request that accountants issue a comfort letter with respect to certain information included in the registration statement (or official statement, offering circular or offering memorandum) as one of a number of procedures that may be used by the underwriters to establish that they have conducted a reasonable investigation. AU 634 provides guidance to accountants for performing and reporting on the results of engagements to issue comfort letters to underwriters. It is important to note that neither the Act nor AU 634 obligates the accountant to issue a comfort letter and there is nothing that would preclude the underwriters from performing all of the “due diligence” procedures the underwriters believe are necessary in order to demonstrate that a reasonable investigation was performed. AU 634.12 states, in part, “What constitutes a reasonable investigation of unaudited financial information sufficient to satisfy an underwriter’s purposes has never been authoritatively established. Consequently, only the underwriter can
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determine what is sufficient for his or her purposes. Accountants will normally be willing to assist the underwriter, but the assistance accountants can provide by way of comfort letters is subject to limitations. One limitation is that independent accountants can properly comment in their professional capacity only on matters to which their professional expertise is substantially relevant.” In connection with the determination of the procedures satisfactory for the underwriters’ purposes, the auditor will typically meet with the underwriters and their legal counsel to discuss the procedures the underwriters would like the auditor to perform. In this regard, it is important to note that AU 634.15 states, in part, “any discussion of procedures [between the auditor and underwriter] should be accompanied by a clear statement that the accountants cannot furnish any assurance regarding the sufficiency of the procedures for the underwriter’s purposes.” Paragraph 4 of AU 634 example A illustrates a form of such a disclaimer, “The foregoing procedures do not constitute an audit conducted in accordance with generally accepted auditing standards. Also, they would not necessarily reveal matters of significance with respect to the comments in the following paragraph. Accordingly, we make no representations regarding the sufficiency of the foregoing procedures for your purposes.” Considerations Regarding Auditor Attendance at Due Diligence Meetings with Underwriters Q1: Should the auditor obtain the authorization of company management in order to attend a due diligence meeting with underwriters? A1: Yes. In all cases, it would be advisable for the auditor to obtain the written authorization of company management to attend any due diligence meeting with underwriters. Such authorization may include the auditor obtaining the company’s consent to meet with representatives of the underwriters and their legal counsel and obtaining the company’s agreement that the auditor will not be held responsible should the underwriters decide not to move forward with the offering (or only to proceed on less favorable terms). In many cases, the auditor may decide it is appropriate to attend a due diligence meeting with underwriters and their legal counsel only when the auditor also has been engaged by the company to issue a comfort letter to the underwriters in connection with the securities offering. Ethics Standard Section ET 301, Confidential Client Information, states that a member in public practice “shall not disclose any confidential client information without the specific consent of the client.” Accordingly, it would be advisable for the auditor to obtain the written authorization of the client to disclose confidential client information to the underwriters, subject to the considerations Page 5 of 32
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discussed in this paper and applicable professional standards. In many cases, the client may request that the underwriters execute a separate confidentiality agreement, and it is reasonable to expect that the underwriters would become privy to otherwise confidential client information in the course of conducting their due diligence investigation. To the extent the client places any limits on the nature or scope of matters the auditor may address, including confidential client information, the auditor should consider advising the underwriters of such limitations in writing in advance of any due diligence meeting, possibly through appropriate modifications to a letter similar to Exhibit I to this paper. Q2: Is it inappropriate for an auditor to meet privately with underwriters (that is, without management of the company present) to discuss matters pertaining to the company as part of an underwriters’ due diligence in connection with a securities offering? A2: No. However, it is generally more productive for an auditor to attend due diligence meetings with underwriters that also include knowledgeable representatives of financial management of the company, and this is the preferred approach. Management is responsible for the company’s financial statements and internal controls and for the other parts of the registration statement (or official statement, offering circular or offering memorandum). Accordingly, it would be more appropriate for representatives of management to address specific underwriters’ inquiries about the company’s financial affairs, such as its accounting policies and underlying accounting estimates. In some cases, such as questions calling for speculative, subjective or forward-looking responses, the auditor may have no basis for evaluating the accuracy or completeness of management’s response. However, in other cases, the auditor may have a basis to believe that management’s response might be inaccurate or incomplete. In those circumstances, the auditor should discuss such concerns with representatives of management, perhaps following the conclusion of the due diligence meeting with underwriters and as timely as practicable. If, based on those discussions, the auditor concludes, in his or her judgment, that management’s response was inaccurate or incomplete, the auditor should request that management correct or supplement its response to the underwriters. If management declines to do so, the auditor should consider discussing the matter with its attorney and consider the appropriate course of action, including (1) notification of the company’s audit committee, (2) withholding the auditor’s consent to the use of audit reports proposed to be included or Page 6 of 32
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incorporated by reference in the registration statement (or official statement, offering circular or offering memorandum), and/or (3) resignation from the audit relationship. As outlined elsewhere in this paper, there may be a variety of questions to which it generally would be inappropriate for the auditor to respond. In agreeing to meet with the underwriters, the auditor should consider making clear that the auditor retains the prerogative to determine those questions to which it would be appropriate for the auditor to respond. The auditor also should consider maintaining contemporaneous documentation in the workpapers regarding the nature of the questions asked by the underwriters and/or their legal counsel and any responses provided. Further, the auditor should consider making clear to the underwriters that the auditor’s silence does not necessarily mean the auditor agrees with any statements or responses made by management. The auditor should consider having two representatives attend any meeting with underwriters. In most cases, the auditor’s attendance with management at a due diligence meeting with underwriters will satisfy the objectives of the underwriters. However, in some cases, the underwriters still might request to also meet with the auditor privately, outside the presence of management. If the auditor agrees to meet privately with the underwriters, the nature of the questions to which the auditor would consider it appropriate to respond, and the scope of any related responses, would be no broader than if management of the company were present. Further, all of the considerations discussed elsewhere in this paper would apply to any private meeting with the underwriters. Q3: Should there be any documented conditions regarding the auditor’s attendance at any due diligence meetings with underwriters in connection with a securities offering? A3: Yes. AU 634 specifies a number of conditions and limitations related to the comfort letter issued to the underwriters. Many of these conditions and limitations would be equally applicable to due diligence meetings with underwriters. In addition, the auditor should consider clarifying other conditions and limitations that may be unique to oral communications. The auditor should consider communicating in writing and in advance to the company and the underwriters the conditions and limitations applicable to the auditor’s attendance at a due diligence meeting with underwriters. The auditor might request that Page 7 of 32
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authorized representatives of the company and the underwriters acknowledge and agree to those conditions and limitations. If the underwriters decline to agree to those conditions and limitations, or if they expressly reject any or all of them, the auditor should consider declining to attend the due diligence meeting. The auditor should consider whether it is appropriate to specify the following conditions and limitations on the auditor’s attendance at any due diligence meeting with underwriters. An example letter that an auditor might use is included as Exhibit I to this paper. • The auditor communicates through its reports on the company’s financial statements taken as a whole [and on whether management’s assessment of the effectiveness of internal control over financial reporting is fairly stated in all material respects, and on whether the company maintained, in all material respects, effective internal control over financial reporting,] and communicates specifically to underwriters through the comfort letter, which is restricted to the specific use of the underwriters; The audits [and reviews] were directed to the company’s financial statements taken as a whole [and its internal control over financial reporting], and should not be taken to supplant other inquiries or procedures that the underwriters determine to be necessary for purposes of their investigation of the affairs of the company in connection with the securities offering; The auditor does not express any form of assurance with respect to any specific elements of the company’s financial statements [or its internal control over financial reporting]; The auditor has no responsibility for the underwriters’ due diligence decisions, including any use of the company’s financial statements [or its management’s assessment of the effectiveness of the company’s internal control over financial reporting] or the auditor’s report[s]; The auditor has not performed any additional procedures for the purpose of responding to inquiries of the underwriters; The audits [and reviews] were not planned or conducted in contemplation of responding to inquiries from the underwriters, nor do the auditor’s responses alter the scope of such engagements; [The review(s) completed were substantially less in scope than an audit and consisted principally of inquiries of management and the application of analytical procedures]; Any responses to inquiries of the underwriters will be made to the best of the auditor’s knowledge and belief, but any response
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would not necessarily reveal matters of significance with respect to the subject matter of the underwriters’ inquiry; The auditor makes no representations as to the sufficiency, for the purposes of the underwriters, of the underwriters’ inquiries and the auditor’s responses; The auditor assumes no duty to respond or to update responses after the date on which they are given; The auditor makes no representations as to questions of legal interpretation or the adequacy of disclosure in the [registration statement, official statement, offering circular or offering memorandum] or as to whether any material facts have been omitted; The auditor will not meet with anyone other than the company’s management, its legal counsel and the underwriters and their legal counsel; There is no contractual relationship between the auditor and the underwriters or their legal counsel as a result of communications with respect to the securities offering; the underwriters and their legal counsel do not acquire any rights against the auditor that the underwriters and their legal counsel otherwise would not have had, nor does the auditor assume any duties or obligations that the auditor otherwise would not have had as a result of communications with respect to the securities offering; The auditor will respond to questions to the extent he or she deems appropriate considering applicable standards. Those standards limit the matters on which the auditor may properly comment to those to which his or her professional expertise is substantially relevant and involve factual and objective matters; When appropriate, the auditor may suggest that the underwriters redirect the inquiry to a company representative; The underwriters should not construe the auditor’s silence or failure to comment on statements that may be made by others at any meeting as any form of agreement or assurance regarding either the completeness or accuracy of those statements; Company management is responsible for (1) the accuracy and completeness of the disclosures in the [registration statement, official statement, offering circular or offering memorandum]; (2) the contents and fair presentation of the (consolidated) financial statements of the company in accordance with generally accepted accounting principles [and for its assessment of the effectiveness of the company’s internal control over financial reporting]; (3) maintaining effective internal control over financial reporting and effective disclosure controls and procedures; and
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(4) ensuring that the company complies with the laws and regulations applicable to its activities; and The auditor’s responses are subject to the same restrictions as the comfort letter with respect to the underwriters’ use or reference.
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Q4:
Is it appropriate for an auditor to address questions from the underwriters regarding the auditor’s independence (under SEC, PCAOB, and/or AICPA standards)? A4: Yes. The auditor may refer the underwriters to comments on independence in the written comfort letter, a draft of which may have been provided to the underwriters prior to the due diligence meeting. AU 634.31 provides guidance and example language for an auditor to consider using in a comfort letter to confirm independence. As indicated in AU 634.31, any additional comments on independence generally would be unnecessary. Accordingly, the auditor should refrain from making any additional oral comments on the auditor’s independence.
Q5:
Is it appropriate for an auditor to address questions from the underwriters regarding the length of the audit relationship and members of the audit engagement team? A5: Yes. The auditor may respond with factual information regarding the period of time that the auditing firm has served as the issuer’s principal auditor and regarding the audit engagement team (e.g., identity of the key members of the audit team; tenure of the lead (or coordinating) audit partner and the concurring (or reviewing) partner) to the extent consistent with any applicable privacy statutes, rules or regulations.
Q6:
Is it appropriate for an auditor to address questions from the underwriters regarding a predecessor auditor? A6: Yes. The auditor may identify the predecessor auditor because the predecessor auditor’s identity is usually a matter of public record. In addition, the auditor may confirm whether the communications between the successor auditor and the predecessor auditor, as required under AU 315, Communications Between Predecessor and Successor Auditors, have occurred, but the auditor should not discuss with the underwriters the specific matters previously discussed with the predecessor auditor. The auditor may also refer the underwriters to the Form 8-K filed by the company reporting the auditor change for additional information. However, the successor auditor would have no basis to respond to other specific questions Page 10 of 32
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regarding any predecessor auditor (e.g., the predecessor auditor’s independence; disagreements between management and the predecessor auditor; reasons for the predecessor auditor’s resignation or dismissal; quality of the audit work performed by the predecessor auditor). Q7: Is it appropriate for an auditor to address questions from the underwriters regarding the nature of other services the auditor has provided to the company? A7: Yes. To the extent that the registration statement (or official statement, offering circular or offering memorandum) incorporates by reference the company’s Annual Report (e.g., Form 10-K or 10-KSB), the scope of the underwriters’ due diligence may extend to the disclosures under Item 14 of the Annual Report regarding fees paid to the principal auditor for services during the previous two fiscal years. Accordingly, the underwriters might want to confirm directly with the principal auditor that the amount of fees is not misstated. In such situations, the auditor may respond to questions from the underwriters regarding the amounts of fees billed and the general nature of the related services. However, the auditor should not comment on the classification of the fees for purposes of the disclosure under Item 14 (i.e., audit, audit-related, tax, and all other). AU 634.57 states that the auditor may provide negative assurance in a comfort letter as to whether certain information that is part of the registration statement is in conformity with the disclosure requirements of Regulation S-K, provided the information meets specified conditions. Because the requirements for Item 14 of Form 10-K derive from Item 9(e) of Schedule 14A, the disclosure requirements for auditor fees are not specified in Regulation S-K and the auditor should not comment, either orally or in writing, on the conformity of the Item 14 information with those disclosure requirements. In addition, because the classification of auditor fees required under Item 14 is a matter of legal interpretation and not the responsibility of the auditor, the auditor should not provide, either orally or in writing, negative assurance, or any other form of assurance, on the appropriateness of such classification or the manner in which such classification has been made. Additionally, consistent with A4 above, the auditor should refrain from discussing any implications to the auditor’s independence of specific services, because such implications would have been specifically considered in, and implicitly confirmed by, the auditor’s confirmation of independence in the comfort letter to underwriters. Page 11 of 32
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Instead, the auditor should refer the underwriters to comments on independence in the written comfort letter, a draft of which may have been provided to the underwriters prior to the due diligence meeting. Q8: Is it appropriate for an auditor to address questions from the underwriters regarding whether the company’s audit committee has pre-approved all services? A8: Yes. The auditor may refer the underwriters to comments on independence in the written comfort letter, a draft of which may have been provided to the underwriters prior to the due diligence meeting. The auditor also may point out that audit committee preapproval of the auditor’s services as required by Regulation S-X Rule 2-01(c)(7) is implicit in the confirmation of independence in the comfort letter. Consistent with A4 above, the auditor should refrain from discussing the general or specific pre-approval of the audit committee with respect to any services rendered. Further, the auditor should refer questions about the audit committee’s preapproval policies and practices to a representative of management, because establishing and monitoring those policies and practices are beyond the scope of the auditor’s responsibilities.
Q9:
Is it appropriate for an auditor to address questions from the underwriters regarding specified elements, accounts, or items of the financial statements? A9: No. An audit of a company’s financial statements in accordance with applicable auditing standards (whether PCAOB or AICPA standards) is designed to provide the auditor with an adequate basis upon which to form an opinion on the company’s financial statements taken as a whole, and not to render an opinion on specified elements, accounts, or items of a financial statement. As a result, an audit of the company’s financial statements would not provide the auditor with an adequate basis upon which to respond to underwriters’ questions regarding specified elements, accounts, or items of the financial statements. The auditor should not report orally on specified elements without performing adequate procedures in accordance with AU 6232.
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AU 623, Special Reports, addresses auditors’ reports issued in connection with an examination of specified elements, accounts, or items of a financial statement. AU 623.12 states, in part, “When expressing an opinion on one or more specified elements, accounts, or items of a financial statement, the auditor should plan and perform the audit and prepare his or her report with a view to the purpose of the engagement.” AU 623.13 goes on to state “An engagement to express an opinion on one or more specified elements, accounts, or items of a financial statement may be undertaken as a separate engagement or in conjunction with an
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In connection with a comfort letter to underwriters, AU 634 specifically provides a basis for the auditor to comment on tables, statistics, and other financial information appearing outside the basic financial statements in the offering document. In order to avoid any misunderstanding regarding the procedures performed, findings obtained and the related level of assurance provided, the auditor should refrain from commenting orally on tables, statistics, and other financial information appearing outside the basic financial statements in the registration statement (or official statement, offering circular or offering memorandum). Instead, the auditor should refer the underwriters to the related procedures and findings in the written comfort letter, a draft of which may have been provided to the underwriters prior to the due diligence meeting. Q10: With respect to the auditor’s reports included or incorporated by reference in the offering document, is it appropriate for an auditor to address questions from the underwriters regarding the scope of the audit of the financial statements [and internal control over financial reporting] or the nature of the audit procedures performed in specific areas? A10: Yes, however, the auditor should exercise care in discussing audit scope and audit procedures. The auditor should make it clear that the audits covered only the financial statements [and internal control over financial reporting] for the dates and periods referred to in the auditor’s report included or incorporated by reference in the offering document. Other financial statements included or incorporated by reference in the offering document may be unaudited, or may have been reported on by other auditors. The auditor should remind the underwriters that the scope of the audit of the financial statements [and internal control over financial reporting] was determined given the objective of an audit of the financial statements taken as a whole [and whether effective internal control over financial reporting was maintained in all material respects]. The auditor also should remind the underwriters that the scope of audit work in a particular area was not designed to express an opinion regarding only the particular element of the financial statements [or internal control over financial reporting].
audit of financial statements. In either case, an auditor expresses an opinion on each of the specified elements, accounts, or items encompassed by the auditor’s report; therefore, the measurement of materiality must be related to each individual element, account, or item reported on rather than to the aggregate thereof or to the financial statements taken as a whole. Consequently, an audit of a specified element, account, or item for purposes of reporting thereon is usually more extensive than if the same information were being considered in conjunction with an audit of financial statements taken as a whole.”
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The auditor should refrain from discussing risk assessments that influenced the nature, scope and timing of audit procedures with respect to specific accounts [or controls]. Risk assessments are integral to the audit process, but are not otherwise reported to third parties. Any identification of audit risk assessments to the underwriters could be viewed as providing direction to the scope and extent of the underwriters’ own due diligence inquiries, for which the auditor should not assume any responsibility as discussed in A17 below. The auditor should remind the underwriters that the scope of an audit of the financial statements is set forth in the auditor’s report: • An audit is conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States) (or generally accepted auditing standards, where appropriate), which require that the auditor plan and perform the audit to obtain reasonable assurance whether the financial statements are free of material misstatement; An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements; and An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.
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In the normal case, the scope of the audit would enable the auditor to express an unqualified opinion on the financial statements. If there were any limitation imposed on the scope of the audit, the matter would be dealt with in the auditor’s report. [The auditor should remind the underwriters that the scope of an audit of internal control over financial reporting is also set forth in the auditor’s report: • An audit of internal control over financial reporting is conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), which require that the auditor plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects; An audit includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment of the effectiveness of internal control over financial reporting, testing and evaluating the design and operating effectiveness of internal control over financial reporting; and Page 14 of 32
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• Performing other procedures as considered necessary in the circumstances.]
The auditor may consider describing to underwriters the nature of audit procedures performed on certain financial statement elements in forming an opinion on the financial statements taken as a whole; however, the auditor should make it clear that no assurance is provided to the underwriters on these specific items beyond that conveyed by the auditor’s report on the financial statements. [The auditor may consider describing to underwriters the nature of audit procedures performed on certain elements of internal control over financial reporting in forming an opinion on management’s assessment of internal control over financial reporting; however, the auditor should make it clear that no assurance is provided to the underwriters on these specific items beyond that conveyed by the auditor’s report on internal control.] In addition, the auditor should refrain from discussing findings, or any conclusions drawn, from the application of audit procedures, as such statements may be interpreted as providing assurance regarding elements of the financial statements [or internal control over financial reporting], which would be inappropriate, as discussed in the response above. If unaudited financial statements are included or incorporated by reference in the offering document, the auditor should refer the underwriters to the comfort letter, a draft of which may have been provided to the underwriters prior to the due diligence meeting, which describes the nature and scope of the auditor’s procedures, if any, regarding such unaudited financial statements. Q11: Is it appropriate for an auditor to address questions from the underwriters regarding the auditor’s communications with a company’s audit committee under AU 380, Communication With Audit Committees, or Rule 2-07 of Regulation S-X, Communication With Audit Committees? A11: No. AU 380 requires the auditor to determine that certain matters related to the conduct of an audit are communicated to those responsible for oversight of a company’s financial reporting process, typically a company’s audit committee. These required communications include: • the methods used to account for significant unusual transactions and the effect of significant accounting policies in controversial
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or emerging areas for which there is a lack of authoritative guidance or consensus; the process used by management in formulating particularly sensitive accounting estimates and about the basis for the auditor’s conclusions regarding the reasonableness of those estimates; adjustments arising from the audit, whether or not recorded by the entity, that could, either individually or in the aggregate, have a significant effect on the entity’s financial reporting process; uncorrected misstatements that were determined by management to be immaterial, both individually and in the aggregate, to the financial statements taken as a whole; the auditor’s judgments about the quality, not just the acceptability, of the entity’s accounting principles as applied in its financial reporting (including the selection of new or changes to accounting policies; estimates, judgments, and uncertainties; unusual transactions; and accounting policies relating to significant financial statement items, including the timing of transactions and the period in which they are recorded); any disagreements with management, whether or not satisfactorily resolved, about matters that individually or in the aggregate could be significant to the entity’s financial statements or the auditor’s report (including the application of accounting principles; the basis for management’s judgments about accounting estimates; the scope of the audit; disclosures to be included in the entity’s financial statements; and the wording of the auditor’s report); management’s consultation with other accountants about auditing and accounting matters, of which the auditor is aware; major issues discussed with management in connection with the initial or recurring retention of the auditor (including the application of accounting principles and auditing standards); and serious difficulties encountered in dealing with management related to the performance of the audit.
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AU 380.03 specifies “The communications may be oral or written. If information is communicated orally, the auditor should document the communication by appropriate memoranda or notations in the working papers. When the auditor communicates in writing, the report should indicate that it is intended solely for the information and use of the audit committee or the board of directors and, if appropriate, management, and is not intended to be and should not be used by anyone other than these specified parties.”
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Based on the restriction on the reports under AU 380.03, an auditor should not discuss any of the required audit committee communications with the underwriters. However, the auditor may confirm to the underwriters that the auditor communications with the audit committee required by AU 380 have occurred, including the dates on which such communications occurred. Separately, Rule 2-07(a) of Regulation S-X requires the auditor to communicate to the audit committee of an issuer, prior to the filing of the audit report with the SEC, (1) all critical accounting policies and practices to be used, (2) all alternative treatments within generally accepted accounting principles for policies and practices related to material items that have been discussed with the issuer’s management, including the ramifications to the use of such alternative disclosures and treatments and the treatment preferred by the auditor, and (3) other material written communications between the auditor and the management of the issuer. Similarly, the auditor may confirm to the underwriters that the communications with the audit committee as required under Regulation S-X Rule 2-07(a) have occurred, including the dates on which such communications occurred. In situations where, based on the underwriters’ questions, the auditor has reason to believe that the company has provided the underwriters any of the auditor’s reports to the audit committee (or the information contained therein), the auditor should consider emphasizing (1) the restricted use of such reports, (2) the auditor did not authorize any such distribution, and (3) the auditor does not consent to the underwriters’ use of, or reliance on, such reports. See A12 and A13 below for considerations regarding any auditor communications with the audit committee concerning internal control matters and possible fraud or illegal acts, respectively. Q12: Is it appropriate for an auditor to address questions from the underwriters regarding internal control matters (e.g., material weaknesses, reportable conditions/significant deficiencies, management letter comments)? A12: No. With respect to a report to the audit committee regarding significant deficiencies in internal control, AU 325.10 states, “The report should state that the communication is intended solely for the information and the use of the audit committee, management, and others within the organization and is not intended to be and should not be used by anyone other than these specified parties. When there are requirements established by governmental authorities to furnish such reports, specific reference to such regulatory Page 17 of 32
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authorities may be made.” Paragraph 210 of PCAOB Auditing Standard No. 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements (“PCAOB 2”) provides for a similar restriction on written communications about deficiencies in internal control. AU 634.29 specifically prohibits the auditor from referring in a comfort letter to reports issued under AU 325, Communication of Internal Control Related Matters Noted in an Audit, or to any restricted use reports issued to a company in connection with procedures performed on the company’s internal control in accordance with AT 501, Reporting on an Entity’s Internal Control Over Financial Reporting. Footnote 24 to AU 634.33 prohibits the auditor from referring in a comfort letter to compliance with the provisions of the 1934 Act regarding internal accounting control. That footnote refers to AT 501.82, which indicates that it is a legal determination whether a company is in compliance with the provisions of the Foreign Corrupt Practices Act of 1977 (“FCPA”) regarding internal accounting control. PCAOB 2 supersedes both AU 325 and AT 501 when an auditor performs an integrated audit of financial statements and internal control over financial reporting. In an integrated audit, the auditor may issue a combined report (i.e., one report containing both an opinion on the financial statements and the opinion on internal control over financial reporting) or separate reports on the company’s financial statements and on internal control over financial reporting. Such report(s) are required to be filed with the company’s Form 10-K, Form 10-KSB, Form 20-F, or Form 40-F and will be a matter of public record. Under PCAOB 2, an adverse opinion on an entity’s internal control over financial reporting requires the auditor to identify the material weaknesses that lead to such conclusion. Based on the restriction on the reports provided under AU 325 and paragraph 210 of PCAOB 2, an auditor should not discuss with the underwriters the subject matter of the respective communications about internal control matters. However, the auditor may confirm to the underwriters that the required auditor communications have occurred, including the dates on which such communications occurred. The auditor also may direct the underwriters to read any management assessment of the effectiveness of internal control over financial reporting and any related auditor attestation report that may be included in the company’s filings with the SEC. Page 18 of 32
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An instruction to Item 308 of Regulation S-K, Item 308 of Regulation S-B, and Item 15 of Form 20-F, and General Instruction B.6 of Form 40-F, each require a company to maintain evidential matter, including documentation, to provide reasonable support for management’s assessment of the effectiveness of the company’s internal control over financial reporting. Item 308(a)(3) of Regulations S-K and S-B, Item 15(b)(3) of Form 20-F, and General Instruction B.6(c)(3) of Form 40-F specifically indicate that management is not permitted to conclude that internal control over financial reporting is effective if there are one or more material weaknesses in internal control over financial reporting. The auditor should refer questions regarding material weaknesses, or other internal control matters, to company management, which is responsible for establishing and maintaining adequate internal control over financial reporting for the company. The company’s own documentation should be available to address underwriters’ questions regarding internal control matters, regardless of the form of the auditor’s report under PCAOB 2. In situations where, based on the underwriters’ questions, the auditor has reason to believe that the company has provided the underwriters any of the auditor’s reports provided under either AU 325 or paragraph 210 of PCAOB 2 (or the information contained therein), the auditor should consider emphasizing (1) the restricted use of such reports, (2) the auditor did not authorize any such distribution, and (3) the auditor does not consent to the underwriters’ use of, or reliance on, such reports. Q13: Is it appropriate for an auditor to address questions from the underwriters regarding the auditor’s awareness of any instances of fraud or illegal acts? A13: No. Even when the client has authorized the auditor to disclose confidential client information, professional auditing standards do not provide for the auditor to explicitly comment on, or provide any form of assurance regarding, fraud or illegal acts. Accordingly, it would be appropriate for the auditor to request the underwriters to redirect to management any questions concerning fraud or illegal acts. The auditor should follow the considerations in A2 above should there be any concerns as to whether management’s responses might be inaccurate or incomplete. AU 316.79 outlines the requirements for auditor’s communication to management and the audit committee concerning possible fraud. AU 316.80 and 316.81 discuss considerations for auditor’s communication with the audit committee concerning risks of fraud. Page 19 of 32
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AU 316.82 then states, in part, “The disclosure of possible fraud to parties other than the client’s senior management and its audit committee ordinarily is not part of the auditor’s responsibility and ordinarily would be precluded by the auditor’s ethical or legal obligations of confidentiality unless the matter is reflected in the auditor’s report.” While AU 316.82 indicates that a duty to disclose to parties outside the entity may exist3, it does not suggest that there is any duty to communicate possible fraud to underwriters in connection with their due diligence inquiries. AU 317.17 outlines the requirements for auditor’s communication to the audit committee with respect to possible illegal acts. AU 317.18 to 317.21 discuss the potential effects of illegal acts on the auditor’s report. AU 317.23 then states, in part, “Disclosure of an illegal act to parties other than the client’s senior management and its audit committee or board of directors is not ordinarily part of the auditor’s responsibility, and such disclosure would be precluded by the auditor’s ethical or legal obligation of confidentiality, unless the matter affects his opinion on the financial statements.” While AU 317.23 indicates that a duty to disclose to parties outside the entity may exist4, it does not suggest that there is any duty to communicate illegal acts to underwriters in connection with their due diligence inquiries. As further discussed in A18 below, the auditor has certain duties under professional auditing standards, and liabilities under Section 11 of the Act, in connection with filings under the federal securities laws. When the auditor is aware of the existence of possible fraud or illegal acts concerning the prospective issuer, the auditor should be satisfied that such matters have been adequately disclosed in the registration statement (or official statement, offering circular or
3
4
AU 316.82 reminds auditors that a duty to disclose to parties outside the entity may exist (1) to comply with legal and regulatory requirements, (2) to a successor auditor, (3) in response to a subpoena, and (4) to a funding agency or other specified agency in accordance with requirements for the audits of entities that receive governmental financial assistance. Auditors are further reminded that, because potential conflicts between the auditor’s ethical and legal obligations for confidentiality of client matters may be complex, the auditor may wish to consult with legal counsel before discussing possible fraud with parties outside the client. AU 317.23 reminds auditors that a duty to disclose to parties outside the entity may exist (1) when the entity reports an auditor change under the appropriate securities law on Form 8-K, (2) to a successor auditor, (3) in response to a subpoena, and (4) to a funding agency or other specified agency in accordance with requirements for the audits of entities that receive governmental financial assistance. Auditors are further reminded that, because potential conflicts between the auditor’s ethical and legal obligations for confidentiality of client matters may be complex, the auditor may wish to consult with legal counsel before discussing possible illegal acts with parties outside the client.
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offering memorandum). If concerns as to possible fraud or illegal acts have not been resolved prior to the proposed securities offering, the auditor should consider whether (1) it is appropriate to be associated with such proposed securities offering, (2) the auditor should refuse to consent to the use of his or her report on the company’s financial statements, and (3) the auditor should refuse to issue a comfort letter. Q14: Is it appropriate for an auditor to address questions from the underwriters that are subjective in nature (e.g., the competence of the controller or CFO, adequacy of management information systems or internal audit function, effectiveness of members of the company’s audit committee), require a qualitative or judgmental assessment (e.g., the degree of aggressiveness or conservatism of the company’s accounting principles and their application), involve hypothetical matters (e.g., how would the scope of internal audits been different had the audit partner headed the function), involve speculation regarding possible future events (e.g., future management changes), or would otherwise require the auditor to speak in the role similar to that of management of a company? A14: No. AU 634.12 states, in part, “One limitation is that independent accountants can properly comment in their professional capacity only on matters to which their professional expertise is substantially relevant.” Similarly, AU 9634.07 states, “The auditor should not comment on matters that are primarily subjective or judgmental in nature …” As a result, an auditor should carefully consider whether any question raised by the underwriters meets such condition. Accordingly, the auditor should not respond to questions from underwriters that are subjective in nature, require a qualitative or judgmental assessment, involve hypothetical matters, involve speculation regarding possible future events, or would otherwise require the auditor to speak assuming a role similar to that of management of the company. Q15: Is it appropriate for an auditor to address questions from the underwriters regarding the relationship of the company’s accounting principles or practices compared with any other companies (including other companies in the company’s industry)? A15: Yes. However, the auditor should not comment on whether a company’s accounting principles and practices are consistent with, or different than, other companies without an adequate basis for providing such comments. In most cases, the audit of the company’s financial statements under the standards of the PCAOB, or AICPA generally accepted auditing standards, will not provide such a basis. Page 21 of 32
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It is explicit in the auditor’s report on the company’s financial statements that the financial statements are presented in accordance with generally accepted accounting principles. AU 411.04 explains: “The auditor’s opinion that financial statements present fairly an entity’s financial position, results of operations, and cash flows in conformity with generally accepted accounting principles should be based on his or her judgment as to whether (a) the accounting principles selected and applied have general acceptance; (b) the accounting principles are appropriate in the circumstances; (c) the financial statements, including the related notes, are informative of matters that may affect their use, understanding, and interpretation; (d) the information presented in the financial statements is classified and summarized in a reasonable manner, that is, neither too detailed nor too condensed; and (e) the financial statements reflect the underlying transactions and events in a manner that presents the financial position, results of operations, and cash flows stated within a range of acceptable limits, that is, limits that are reasonable and practicable to attain in financial statements.” However, PCAOB and AICPA auditing standards do not require the auditor to benchmark the accounting principles of the company being audited to other specific companies. Instead, the auditor is only required to assess the “general acceptance” and “appropriateness in the circumstances” of the company’s accounting principles. If the auditor determines he or she has an adequate basis to comment on the relationship of a company’s accounting principles and practices to those of other companies, the auditor should limit comments and observations regarding other companies to matters within the public record or otherwise in the public domain. The auditor should exercise care that any comments or observations do not indirectly divulge confidential information obtained from services rendered by the auditor or the audit firm to other companies. That is, any response to the underwriters should not violate ET 301 of the AICPA Code of Professional Conduct, which states, “A member in public practice shall not disclose any confidential client information without the specific consent of the client.” Q16: Is it appropriate for an auditor to address questions from the underwriters regarding the completeness of a company’s management’s discussion and analysis of financial condition and results of operations (MD&A) or the compliance of such MD&A with the SEC’s published rules and regulations?
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A16: No. AU Section 550, Other Information in Documents Containing Audited Financial Statements, establishes the auditor’s responsibility with respect to other elements of the annual report such as MD&A. AU 550.04 states “Other information in a document may be relevant to an audit performed by an independent auditor or to the continuing propriety of his report. The auditor’s responsibility with respect to information in a document does not extend beyond the financial information identified in his report, and the auditor has no obligation to perform any procedures to corroborate other information contained in a document. However, he should read the other information and consider whether such information, or the manner of its presentation, is materially inconsistent with information, or the manner of its presentation, appearing in the financial statements. If the auditor concludes that there is a material inconsistency, he should determine whether the financial statements, his report, or both require revision. If he concludes that they do not require revision, he should request the client to revise the other information. If the other information is not revised to eliminate the material inconsistency, he should consider other actions such as revising his report to include an explanatory paragraph describing the material inconsistency, withholding the use of his report in the document, and withdrawing from the engagement. The action he takes will depend on the particular circumstances and the significance of the inconsistency in the other information.” However, AU 550 does not provide any basis for the auditor to provide negative assurance, or any other form of assurance, to the underwriters regarding MD&A. AU 634.57 states that the auditor may provide negative assurance in a comfort letter as to whether certain information in the registration statement is in conformity with the disclosure requirements of Regulation S-K, provided the information meets specified conditions. However, AU 634.57 does not cite the disclosure requirements of S-K Item 303 as meeting the necessary conditions. Accordingly, the auditor should not comment on whether MD&A in the registration statement (or official statement, offering circular or offering memorandum) complies with the SEC’s published rules and regulations unless the auditor has completed an attestation engagement under AT 701 as discussed below. Auditors are permitted by AT 701, Management’s Discussion and Analysis, to issue either examination5 or review6 reports regarding a
5
The auditor’s objective in an engagement to examine MD&A is to express an opinion on MD&A taken as a whole by reporting whether: (1) The presentation includes, in all material respects, the required elements of the rules and regulations adopted by the SEC; (2) The
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company’s MD&A. Auditors reporting on MD&A are typically engaged separately from the audit of the financial statements or an integrated audit.7 If the auditor has completed an engagement under AT 701, the company may provide the report to the underwriters and the auditor may refer to such report in the introductory paragraph of the comfort letter. Otherwise, the auditor should not comment on the completeness and Regulation S-K compliance of MD&A in any due diligence meeting with underwriters. Q17: Is it appropriate for an auditor to respond to underwriters’ questions regarding the adequacy of the procedures the underwriters have requested the auditor to perform and report on in the comfort letter? Is it appropriate for an auditor to respond to underwriters’ questions regarding “any other matters that the auditor believes the underwriters should be aware of?” A17: No. AU 634.12 states, in part, “What constitutes a reasonable investigation of unaudited financial information sufficient to satisfy an underwriter’s purposes has never been authoritatively established. Consequently, only the underwriter can determine what is sufficient for his or her purposes.” In connection with discussing potential comfort letter procedures, AU 634.15 states, in part, “any discussion of procedures [between the auditor and underwriter] should be accompanied by a clear statement that the accountants cannot furnish any assurance regarding the sufficiency of the procedures for the underwriter’s purposes.” Paragraph 4 of AU 634 example A illustrates a form of such a disclaimer, “The foregoing procedures do not constitute an audit conducted in
historical financial amounts have been accurately derived, in all material respects, from the entity’s financial statements; and (3) The underlying information, determinations, estimates, and assumptions of the entity provide a reasonable basis for the disclosures contained therein. The auditor’s objective in an engagement to review MD&A is to report whether any information came to the auditor’s attention to cause him or her to believe that: (1) The MD&A presentation does not include, in all material respects, the required elements of the rules and regulations adopted by the SEC; (2) The historical financial amounts included therein have not been accurately derived, in all material respects, from the entity’s financial statements; and (3) The underlying information, determinations, estimates, and assumptions of the entity do not provide a reasonable basis for the disclosures contained therein. An auditor may accept an engagement to examine or review the MD&A presentation of a public entity for an annual period provided the practitioner has audited, in accordance with the standards of the PCAOB, the financial statements for at least the latest annual period to which the MD&A presentation relates and the financial statements for the other periods covered by the MD&A presentation have been audited by the auditor or a predecessor auditor. Under AICPA attestation standards, an examination of MD&A of a non-public entity also may be undertaken by an auditor provided similar conditions have been met.
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accordance with generally accepted auditing standards. Also, they would not necessarily reveal matters of significance with respect to the comments in the following paragraph. Accordingly, we make no representations regarding the sufficiency of the foregoing procedures for your purposes.” AU 634.35.b states, in part, “To avoid any misunderstanding about the responsibility for the sufficiency of the agreed-upon procedures for the underwriter’s purposes, the accountants should not make any statements, or imply that they have applied procedures that they have determined to be necessary or sufficient for the underwriter’s purposes.” AU 634.35.e states, in part, “Since there is no way of anticipating other matters that would be of interest to an underwriter, accountants should not make a general statement in a comfort letter that, as a result of carrying out the specified procedures, nothing else has come to their attention that would be of interest to the underwriter.” With respect to comments on other information in the registration statement (or official statement, offering circular or offering memorandum), AU 634.56 states, in part, “Further, so that there will be no implication that the accountants are furnishing any assurance with respect to the sufficiency of the procedures for the underwriter’s intended purpose, the comfort letter should contain a statement to this effect.” The example comfort letters in AU 634 provide the following example of such a statement, “It should be understood that we make no representations regarding questions of legal interpretation or regarding the sufficiency for your purposes of the procedures enumerated in the preceding paragraph; also, such procedures would not necessarily reveal any material misstatement of the amounts or percentages listed above. Further, we have addressed ourselves solely to the foregoing data as set forth in the registration statement and make no representations regarding the adequacy of disclosure or regarding whether any material facts have been omitted.” As a result, the auditor should not respond to questions regarding the adequacy of the procedures performed for the underwriters’ purposes, nor should the auditor respond to questions regarding the existence of any other matters of which the underwriters should be aware. Q18: Is it appropriate for an auditor to respond to underwriters’ questions regarding the completeness, accuracy and fair presentation of the prospectus and related registration statement (or official statement,
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offering circular or offering memorandum) or whether there are any material misstatements or omissions in the information therein? A18: No. AU 634.60 states, in part, “Except with respect to requirements for financial statements and certain Regulation S-K items [which meet specified conditions such that the auditor may provide negative assurance in a comfort letter as to whether the related disclosure in the registration statement is in conformity with the respective disclosure requirements], the question of what constitutes appropriate information for compliance with the requirements of a particular item of the registration statement form is a matter of legal interpretation outside the competence of accountants. Consequently, the [comfort] letter should state that the accountants make no representations regarding any matter of legal interpretation. Since the accountants will not be in a position to make any representations about the completeness or adequacy of disclosure or about the adequacy of the procedures followed, the letter should so state. It should point out, as well, that such procedures would not necessarily disclose material misstatements or omissions in the information to which the comments relate.” The example comfort letters in AU 634 provide the following example of such a statement, “It should be understood that we make no representations regarding questions of legal interpretation or regarding the sufficiency for your purposes of the procedures enumerated in the preceding paragraph; also, such procedures would not necessarily reveal any material misstatement of the amounts or percentages listed above. Further, we have addressed ourselves solely to the foregoing data as set forth in the registration statement and make no representations regarding the adequacy of disclosure or regarding whether any material facts have been omitted.” The auditor should follow this guidance when attending due diligence meetings with underwriters. AU 711, Filings Under Federal Securities Statutes, requires the auditor to perform certain procedures in connection with an offering of securities under the Act. At or near the effective date, AU 711 requires the auditor to perform procedures, as specified in AU 560.12, with respect to subsequent events that may require adjustment or disclosure in the financial statements in order for them to be fairly stated in conformity with generally accepted accounting principles. Such subsequent events procedures should include: • Reading the latest available interim financial statements and comparing them with the audited financial statements;
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• Inquiring of officers and other executives having responsibility for financial and accounting matters whether the interim statements have been prepared on the same basis as that used for the audited financial statements; Inquiring of, and discussing with, such officers and other executives as to: (a) substantial contingent liabilities or commitments at the date of the audited balance sheet and arising subsequently, (b) any significant change in the capital stock, long-term debt, or working capital, (c) the current status of items that were accounted for in the audited financial statements on the basis of tentative, preliminary, or inconclusive data, and (d) any unusual adjustments subsequent to the date of the audited balance sheet; Reading available minutes of meetings of stockholders, directors, and appropriate committees; as to meetings for which minutes are not available, inquiring about matters dealt with at such meetings; Inquiring of company’s legal counsel concerning litigation, claims, and assessments; and Obtaining a letter of representations from appropriate officials (e.g., CEO and CFO) as to whether any events occurred subsequent to the date of the audited financial statements that in the officer’s opinion would require adjustment or disclosure in these statements.
•
•
• •
In addition, AU 711.10 requires the auditor to perform the following additional procedures, at or near the effective date: • • Reading the entire prospectus and other pertinent portions of the registration statement; and Inquiring of, and obtaining written representations from, officers and other executives responsible for financial and accounting matters about whether any events have occurred, other than those reflected or disclosed in the registration statement, that, in the officers’ or other executives’ opinion, have a material effect on the audited financial statements included therein or that should be disclosed in order to keep those statements from being misleading.
The purposes of the auditor performing the above procedures is to sustain the burden of proof that the auditor has made a “reasonable investigation” under Section 11(b)(3)(B) of the Act (i.e., the auditor’s own due diligence). While these procedures would not necessarily disclose material misstatements or omissions in the information included in the document, the auditor may confirm to the
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underwriters the procedures that the auditor has performed, or will perform, under AU 711. However, except as appropriate in a written comfort letter issued under AU 634, the auditor should not express negative assurance, or any other form of assurance, as to disclosures in the registration statement (or official statement, offering circular or offering memorandum).
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Draft for Discussion Purposes Only – Dated August 23, 2005 Exhibit I Notification to Client and Underwriters Regarding Due Diligence
[Date] [Name of Client] and [Name of Underwriters] [As Representatives of the Several Underwriters] [Address of Underwriters]8 Dear Sirs: In connection with the proposed offering of [describe securities] (the “Offering”) of [client name] (the “Company”) and the underwriters’ due diligence review process related thereto, the Company has authorized us to meet with representatives of [Name of Underwriters] (the “Underwriters”) and other members of the underwriting group, and their legal counsel, collectively the “Underwriter Representatives.”9 In responding to questions from the Underwriter Representatives, we wish to advise you of the following conditions and limitations: 1. [AUDITOR] communicates through its reports on the Company’s (consolidated) financial statements taken as a whole [and on whether management’s assessment of the effectiveness of internal control over financial reporting is fairly stated in all material respects, and on whether the Company maintained, in all material respects, effective internal control over financial reporting]10, and communicates specifically to underwriters through our letter to underwriters (the “Comfort Letter”). The Comfort Letter is solely for the information of its addressees and to assist the underwriters in conducting and documenting their investigation of the affairs of the Company in connection with the offering of the securities covered by the [describe offering document] (the [“Registration Statement,” “Official Statement,” “Offering Circular” or “Offering Memorandum”].
8 9
10
Address should be consistent with the Comfort Letter. If the client has imposed any limitation on the nature or scope of matters the auditor may address or on the auditor’s ability to disclose confidential client information, the notification letter should be modified to state the nature and scope of any client-imposed limitations. Throughout this letter, references pertaining to an integrated audit of financial statements and internal control over financial reporting should be made only when the auditor’s report on internal control over financial reporting is made part of the offering document.
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2. Our audits of the (consolidated) annual financial statements of the Company [included or incorporated by reference] in the [Registration Statement, Official Statement, Offering Circular or Offering Memorandum] were comprised of audit tests and procedures deemed necessary for the purpose of expressing an opinion on such financial statements taken as a whole. [Our audit of management’s assessment of the effectiveness of internal control over financial reporting, and the effectiveness of the Company’s internal control over financial reporting, was comprised of audit tests and procedures deemed necessary for the purpose of expressing an opinion on whether management’s assessment is fairly stated in all material respects, and whether the Company maintained, in all material respects, effective internal control over financial reporting, as of [most recent audited balance sheet date] based on specified criteria, as indicated in our report, which has been made part of the [Registration Statement, Official Statement, Offering Circular or Offering Memorandum].] [Our reviews of the (consolidated) interim financial statements of the Company [included or incorporated by reference] in the [Registration Statement, Official Statement, Offering Circular or Offering Memorandum] were substantially less in scope than an audit and consisted principally of analytical procedures and inquiries deemed necessary for the purpose of determining whether we are aware of any material modifications that should be made to those financial statements for them to be in conformity with accounting principles generally accepted in the United States.] For neither the periods covered by those financial statements nor any other period did we perform procedures for the purpose of expressing an opinion or any other form of assurance on individual account balances or other elements of the Company’s (consolidated) financial statements [or its internal control over financial reporting], and accordingly, we do not express any such opinion or any other form of assurance thereon. Our audits of the Company’s (consolidated) annual financial statements [and the effectiveness of its internal control over financial reporting as of [most recent audited balance sheet date]] should not be taken to supplant other inquiries or procedures that the Underwriters determine to be necessary for purposes of their investigation of the affairs of the Company in connection with the Offering. 3. We have no responsibility for the due diligence decisions of the Underwriters, or any responsibility to advise or consult with the Underwriters regarding the Underwriters’ possible use of the Company’s (consolidated) financial statements [or its management’s assessment of the effectiveness of the Company’s internal control over financial reporting], or our auditor’s report[s] thereon, in connection with their due diligence, and we specifically disclaim any such responsibility. Such matters are solely the Underwriters’ responsibility and judgment.
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4. We have not performed any procedures for the purpose of responding to inquiries of the Underwriter Representatives. Further, our audits [and reviews] (and any other work) were not planned or conducted in contemplation of our responses to inquiries from the Underwriter Representatives, nor do our responses to inquiries of the Underwriter Representatives alter the scope of any such engagements. Our responses to inquiries by the Underwriter Representatives will be provided to the best of our knowledge and belief; however, any response would not necessarily reveal matters of significance with respect to the subject matter of such inquiry. Accordingly, we make no representations as to the sufficiency of the inquiries and our responses for purposes of the Underwriter Representatives. In addition, we assume no duty to respond to any inquiries or to update our responses, if any, after the date on which they are given. 5. It should be understood that we make no representations as to questions of legal interpretation or the adequacy of disclosure in the [Registration Statement, Official Statement, Offering Circular or Offering Memorandum] or as to whether any material facts have been omitted. 6. We will not meet with anyone other than the Company’s management, its legal counsel and the Underwriter Representatives. 7. There is no contractual relationship between [AUDITOR] and any of the Underwriter Representatives as a result of our communications with respect to the Offering. The Underwriter Representatives, individually or collectively, do not acquire any rights against us that they otherwise would not have had, nor do we assume any duties or obligations that we otherwise would not have had as a result of our communications with respect to the Offering. 8. We will respond to questions directed to us to the extent that we deem appropriate considering our professional standards, which limit the matters on which we may properly comment to those to which our professional expertise is substantially relevant and involve factual and objective matters. When it is appropriate in our judgment, we may suggest that the Underwriter Representatives redirect the inquiry to a representative of the Company. Among other things, the Underwriter Representatives should not construe our silence or failure to comment on statements that may be made by others at any meeting as any form of agreement or assurance regarding either the completeness or accuracy of those statements. 9. Management of the Company is responsible for the accuracy and completeness of the disclosures in the [Registration Statement, Official Statement, Offering Circular or Offering Memorandum] and the contents and fair presentation of the (consolidated) financial statements of the Company in accordance with generally accepted accounting principles [and for its assessment of the effectiveness of the Company’s internal control over financial reporting]. Management of the Company also is Page 31 of 32
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responsible for maintaining effective internal control over financial reporting and effective disclosure controls and procedures, and for ensuring that the Company complies with the laws and regulations applicable to its activities. 10. Neither this letter nor our responses, if any, to any inquiries are to be used, circulated, quoted or otherwise referred to within or without the underwriting group for any purpose other than as described in 1. above, including, but not limited to, the registration, purchase, or sale of securities, nor are they to be filed with or referred to in whole or in part in the [Registration Statement, Official Statement, Offering Circular or Offering Memorandum] or any other document. Very truly yours, [AUDITOR]
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