Role of Auditor’s Comfort Letter in Securities Offerings
The issuance of a comfort letter is an essential component of the due diligence process for a securities offering. The auditors for the company prepare and issue comfort letters. The auditors must prepare, issue and deliver the letters in connection with an initial public offering (IPO). In addition, a comfort letter is necessary in many other types of registered and unregistered securities offerings.
The financial statements and other accounting information in an offering document are central to understanding a company’s financial performance and prospects. Thus, it is important that professionals review the financial information a company presents to investors and potential investors.
The comfort letter provides assurances about the financial information the company presents. It also offers a defense to securities liability for the company and the underwriters if either party faces legal action down the road.
Delivery of the Comfort Letter
On the date of pricing, company auditors deliver comfort letters to the underwriters and the underwriters’ legal counsel. The auditors deliver a bring-down comfort letter to the underwriters and their counsel on the closing date of the securities offering. A bring-down comfort letter is a short-form version of the full comfort letter.
The company’s auditors must deliver a comfort letter in almost all types of registered offerings. Certain types of unregistered offerings also involve the delivery of a comfort letter. For example, a Rule 144A offering also requires issuance of a comfort letter. This is a type of unregistered offering that involves participation by qualified institutional investors.
An offering document simply refers to the publicly filed document presented to investors that provides information about the company and the securities being marketed or sold. In a registered offering, the offering document is typically called either a prospectus or a registration statement. In an unregistered offering, the offering document is usually called an offering memorandum.
Protection from Securities Liability
Under U.S. securities laws, the company and underwriters can face liability for inadequate due diligence in preparing the offering document. A comfort letter helps establish a due diligence defense to liability for improper financial disclosure in the offering document. The primary sources of liability under the U.S. securities law derive from three sources:
- Section 11 of the Securities Act of 1933
- Section 12(a)(2) of the Securities Act of 1933
- Rule 10b-5 of the Securities Exchange Act of 1934
Contents of the Comfort Letter
The contents of a comfort letter can vary depending on the norms of the specific industry the company falls within as well as the unique practices of a particular auditing firm. However, most comfort letters contain similar categories of content.
SAS 72 provides guidance on the information that a typical comfort letter should include. SAS 72 refers to the guidance set forth in “Auditing Standards 6101 (AS 6101), Letters for Underwriters and Certain Other Requesting Parties.” While SAS 72 is technically the former name for AS 6101, many auditing firms and lawyers tend to use the former name, SAS 72.
The elements of a comfort letter include:
- Name and addresses of the underwriters
- A statement regarding the independence of the auditors
- A statement that the company’s audited financial statements comply with accounting rules under the Securities Act of 1933
- Negative assurance with regard to the company’s unaudited interim financial statements
- Details on the specific auditing procedures undertaken and the conclusions reached
A Comfort Letter Has Different Levels
The auditors give different levels of comfort on the financial information contained in the company’s offering document. The highest level of assurance is an audit opinion, which auditors can issue on the company’s audited financial statements.
For interim financial statements, which are almost always unaudited and cover periods since the last annual financial statements, a lower level of comfort is provided. This is known as negative assurance. The review of interim financial statements is referred to as SAS 100 limited review. A SAS 100 limited review positions the auditors to provide negative assurance on the interim financial statements. When an auditor gives negative assurance, this means that the auditors have completed specific procedures and concluded that interim financial statements need no material changes to make them comply with Generally Accepted Accounting Principles (GAAP).
Aside from the financial statements, the offering document of the company contains many pieces of financial information. The underwriters will often also request comfort on these items outside of the financial statements themselves. For example, the narrative description of the business often discloses information about net revenues or sales in the narrative description of the business.
Tick-and-tie comfort refers to providing comfort on financial information outside of the financial statements. The underwriters’ counsel will prepare a circle-up of the offering document that indicates the numbers it expects the auditor to provide “tick-mark comfort” on.