Comfort letters: how does SAS 72 affect them?

Conditions once again appear favorable for public offerings of securities. In 1992, the volume of initial public offerings (IPOs) on the New York Stock Exchange (NYSE), which handles about 80% of all IPOs in the United States, was $34.2 billion. The NYSE IPO volume for the first six months of 1993 alone totaled $22.7 billion. In addition, secondary offerings amount to hundreds of billions of dollars each year. What does this mean for CPAs? An increased volume of public offerings means clients may ask CPAs to provide letters to underwriters (often referred to as comfort letters). Underwriters and other parties often require a comfort letter before proceeding with an offering. Involvement in clients' public securities offerings thus gives CPAs a unique opportunity to provide a valuable service.

In February 1993 the American Institute of CPAs auditing standards board issued Statement on Auditing Standards no. 72, Letters for Underwriters and Certain Other Requesting Parties. The new SAS, which supersedes SAS no. 49, Letters for Underwriters, is effective for comfort letters issued on or after June 30, 1993.

SAS no. 72 was issued to clarify who is entitled to obtain comfort letters and to address changes in related authoritative auditing literature. This article should help both CPAs and parties requesting comfort letters understand when such letters may be provided and, when the SAS no. 72 criteria for providing a comfort letter are not met, what other services CPAs can provide.

WHAT ARE COMFORT LETTERS?

Comfort letters are a special type of agreed-upon-procedures report. They are issued in connection with offerings that must be registered with the Securities and Exchange Commission in accordance with the Securities Act of 1933 (the act). They are part of the procedures underwriters undertake to perform and document a "reasonable investigation" of unaudited information included in offering documents. Section 11 of the act provides underwriters with a so-called due diligence defense against possible claims if they have performed such an investigation.

Comfort letters typically include

* A statement regarding the CPA's independence.

* In connection with offerings registered with the SEC, the CPA's opinion on whether the audited financial statements and related schedules comply in terms of form with the act's applicable accounting requirements.

* A description of the procedures applied by the CPA, at the underwriter's request, to unaudited information in the offering documents and the findings obtained.

In SAS no. 72, the ASB expanded the matters CPAs are permitted to address in comfort letters to include financial forecasts and compliance of certain information (such as selected financial data, supplementary financial information, executive compensation and ratios of earnings to fixed charges) with SEC regulation S-K.

WHO MAY OBTAIN COMFORT LETTERS?

Although comfort letters issued under SAS no. 49 were intended only for underwriters with a due diligence defense, such letters often were provided to other parties. SAS no. 72 restricts the availability of comfort letters to the following parties:

1. Named underwriters with a due diligence defense under section 11 of the act.

2. Other parties who have a due diligence defense in connection with a securities offering registered with the SEC. CPAs may provide comfort letters to such requesting parties, which typically include agents, as long as the party provides the CPA with a lawyer's written opinion confirming the party has such a defense. Alternatively, if such parties provide a representation letter as described below, CPAs may provide them with comfort letters.

3. Broker-dealers or other financial intermediaries involved in the offering or placement of securities, as long as the requesting party provides the accountant with a representation letter. Not all securities offerings are required to be registered with the SEC. For instance, certain entities, such as banks and government, municipal and tax-exempt entities, are exempt from registration. Certain offerings also are exempt, including those covered by SEC regulation A, regulation D and rule 144A. Rule underwriters may be involved in such offerings, they may not have a due diligence defense available to them. Further, not every securities offering requires an underwriter's involvement; a broker-dealer or other financial intermediary may be involved in the role of placement or sales agent.

4. Buyers and sellers involved in acquisition transactions, as long as stock is exchanged and the requesting party provides the accountant with a representation letter.

THE REPRESENTATION LETTER

SAS no. 72 requires any party requesting a comfort letter who does not have a section 11 due diligence defense to provide the CPA with a letter, described in paragraph 6 and 7 of the statement, making the following representations:

1. The requesting party is knowledge able about the due diligence review process that would be performed if the securities placement was being registered under the 1933 act.

2. The party's review process is substantially consistent with the due diligence review process that it would per form if the securities placement was being so registered.

Such letters must be signed by the requesting party, not the requesting party's attorney. Although some underwriters and others have argued that the representation letter's wording should be changed, CPAs should not accept a letter that does not conform to the requirements of paragraphs 6 and 7.

The only modification that can be made to the letter is the addition of the following language: "This letter is solely for the information and use of [CPA's name] in connection with the offering of securities covered in the offering circular (or prospectus) and it is not to be used, circulated, quoted or otherwise referred to in whole or in part in the offering circular (or prospectus) or any other document."

IMPLEMENTATION ISSUES 

CPAs may face a number of issues when they implement SAS no. 72.

Can agents be underwriters? If an agent is not named as an underwriter in an offering document, can the CPA use the SEC definition of underwriter in SAS no. 72 to establish that the agent is an underwriter? The answer is no. Determining that someone other than a named underwriter has a due diligence defense under section 11 of the act is a complex legal judgment to be made only by attorneys.

An agent in a medium-term note program is not a named underwriter with a due diligence defense and has to provide an attorney's opinion or the representation letter described above. Only one attorney's opinion need be provided for a given agent in such a program as long as the same lawyer is involved in each portion of the program.

Does SAS no. 72 apply to international offerings? Some questions have arisen over the applicability of SAS no. 72 to international securities offerings. When relevant financial statements have not been audited in accordance with U.S. generally accepted auditing standards, SAS no. 72 often does not apply. If a French company with a French auditor offers securities in France, the AICPA does not require that auditor to follow SAS no. 72, although the policies of multinational accounting firms may vary. Foreign companies may offer their securities for sale in the United States under rule 144A, which exempts them from the act's registration requirements. Although the financial statements included in such offering documents must be reconciled to. U.S. generally accepted accounting principles, the financials do not have to be audited in accordance with U.S. GAAS; thus, SAS no. 72 usually does not apply.

When the use of U.S. GAAS is required, SAS no. 72 generally applies. For instance, SEC registrants are required to have their annual financial statements audited in accordance with U.S. GAAS. If a foreign company offers securities in the United States and that offering is registered under the act, the auditor must comply with SAS no. 72. Alternatively, a U.S. company with a U.S. auditor might undertake a debt offering in a foreign market, for instance, to finance a plant in that country. Since the audit must be conducted in accordance with U.S. GAAS, the U.S. auditor is required to follow SAS no. 72 when providing a comfort letter.

REQUIREMENT FOR A SAS NO. 71 REVIEW

SAS no. 72 raises the threshold for providing negative assurance on interim financial information in comfort letters by requiring CPAs to perform reviews in accordance with SAS no. 71, Interim Financial Information. In practice, many firms performed SAS no. 71 reviews when issuing comfort letters under SAS no. 49. SAS no. 72 requires all CPAs to perform SAS no. 71 reviews when they are requested to provide negative assurance on interim financial information in such comfort letters. This requirement covers all comfort letters, including those requested by named underwriters in connection with registered securities offerings.

While CPAs must perform all procedures required for a SAS no. 71 review, they are not required to issue a SAS no. 71 review report. Example A (paragraphs 4(a)i and 5(a)i) in the appendix to SAS no. 72 provides the appropriate wording for such situations. Alternatively, if a requesting party so desires CPAs may provide a SAS no. 71 review report and attach it to the comfort letter. (See footnote 2 of example A in the SAS no. 72 appendix for appropriate wording.)

Securities offerings usually are undertaken when market conditions are the most favorable, ensuring the highest possible stock or bond price. As a result, there may be tight deadlines for completing comfort letter procedures. Once interim information is available, it should in most circumstances take a CPA only a few days to complete the required SAS no. 71 review. Advance planning and coordination among the client, CPA and underwriter should alleviate most timing problems related to providing negative assurance on interim financial information.

WHEN COMFORT LETTER CRITERIA ARE NOT MET

Some practitioners believe that if a requesting party does not provide a representation letter, footnote 1 of SAS no. 72 precludes them from providing any other services, such as issuing reports in accordance with SAS no. 35, Special Reports-Applying Agreed-upon Procedures to Specified Elements, Accounts, or Items of a Financial Statement. This is not the case! SAS no. 72 recognizes that there may be situations in which comfort letters cannot be provided and, in paragraph 9, says CPAs in such situations may provide these services:

* Issue a SAS no. 71 review report addressed to the client; the client then may provide a copy to the requesting party.

* Issue an agreed-upon-procedures report under SAS no. 35.

The exhibit on this page describes other services that can be rendered when a comfort letter cannot be provided. In SAS no. 35 reports, CPAs can make statements of fact, referring, for instance, to the fact they have audited the financial statements as of a specific date and for the period then ended. They may not, however, state any conclusions; for example, they may not provide positive or negative assurance on the audited financial statements' compliance with SEC rules and regulations.

An example of an agreed-upon-procedures report CPAs can provide in connection with a securities offering is found in example 0 of the May 10, 1991, exposure draft, Letter8 to Underwriters in Conjunction With Filings Under the Securities Act of 1933 and Letters Issued to a Requesting Party in Conjunction With Other Financing Transactions.

LIMIT ON NEGATIVE ASSURANCE ON SUBSEQUENT CHANGES

SAS no. 72 permits CPAs to provide in comfort letters negative assurance on subsequent changes in specified financial statement items (such as net current assets) as of any date less than 135 days from the end of the most recent period for which they performed an audit or a SAS no. 71 review. The ASB considered it inappropriate for CPAs to provide negative assurance on subsequent changes for entities that do not prepare interim financial information on a timely basis. When interim financials are not available, CPAs are limited to reading minutes of recent board of directors meetings and making inquiries of management to ascertain whether there have been any subsequent changes in specified financial statement items.

HELPING CLIENTS

By offering practical guidance on providing comfort letters and implementing SAS no. 72, this article should help CPAs help their clients. CPAs and parties requesting comfort letters now also should have a greater understanding of what services a CPA can provide when the SAS no. 72 criteria have not been met.

EXECUTIVE SUMMARY

* THE AUDITING STANDARDS board issued Statement on Auditing Standards no. 72, Letters for Underwriters and Certain Other Requesting Parties, to clarify who may receive the comfort letters often requested by underwriters in connection with securities offerings.

* SAS NO. 72 expands comfort letters' availability beyond named underwriters with a due diligence defense to include other parties with such a defense, financial intermediaries acting as principals or agents in securities offerings and buyers and sellers in connection with an acquisition as long as there is an exchange of stock.

* TO OBTAIN a comfort letter, parties other than named underwriters must provide an attorney's opinion or a representation letter.

* IN A MAJOR CHANGE, SAS no. 72 raises the threshold for providing negative assurance on interim financial information in comfort letters by requiring CPAs to perform reviews in accordance with SAS no. 71, Interim Financial Information.

* UNDER SAS NO. 72, THE ASB expanded the items CPAs are permitted to address in comfort letters to include financial forecasts and compliance of certain information (such as selected financial data, supplementary financial information, executive compensation and ratios of earnings to fixed charges) with Securities and Exchange Commission regulation S-K.

* SAS NO. 72 RECOGNIZES THERE may be situations in which a comfort letter cannot be provided and says a CPA may provide a SAS no. 71 review report addressed to the client (the client then may provide a copy to the requesting party) and an agreed-upon-procedures report under SAS no. 35, Special Reports--Applying Agreed-upon Procedures to Specified Elements, Accounts, or Items of a Financial Statement.

Other services CPAs can perform

What happens if a requesting party is not able or willing to provide either of the required letters? There still is a wide array of services CPAs can perform in such situations, provided the client agrees, including the following:

* A financial statement audit.

* A review of interim financial information in accordance with Statement on Auditing Standards no. 71, Interim Financial Information.

* Agreed-upon procedures on an element, account or item of a financial statement under SAS no. 35, Special Reports--Applying Agreed-upon Procedures to Specified Elements, Accounts, or Items of a Financial Statement.

* Examination or review of pro forma financial information in accordance with the Statement on Standards for Attestation Engagements (SSAE) Reporting on Pro Forma Financial Information.

* Examination of or agreed-upon procedures on a financial forecast under the Statement on Standards for Accountants' Services on Prospective Financial Information Financial Forecasts and Projections.

* An examination, a review or agreed-upon procedures on an assertion under the SSAE Attestation Standards.

JOHN B. SULLIVAN, CPA, is a partner of Deloitte & Touche in Wilton, Connecticut. He is the chairman of the American Institute of CPAs auditing standards board. JANE M. MANCINO, CPA, is a technical manager in the AICPA auditing standards division.

Ms. Mancino is an employee of the American Institute of CPAs, and her views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.