Pretty much everyone knows by now that audited financial statements are required for offerings under Tier 2 of Regulation A. While the SEC doesn’t require audited financials (or any kind of review by outside accountants) for Tier 1, some states do require audited financials in Tier 1 offerings.
But do you know what the audit letter is supposed to look like? That is important.
Without getting too much into the weeds, the SEC requires that audit reports meet the requirements of Regulation S-X. And that means those audit reports must be “clean.” There can’t be any reservations or qualifications or limitations on scope on the audit. Here’s an example of the sort of thing that may present problems: Freddie’s Ferret Foods has been in operation for three years and ships its premium ferret food to petstores around the country. They’ve never raised funds from outsiders before. In anticipation of making an offering under Regulation A, they hire Anita Accountants LLP to be their auditors. Anita’s auditors find the financial statements to be in excellent shape and say that Freddie’s financial accounting systems are great. However, there’s an issue with accounting for inventory. Auditors have to observe the inventory process (or apply other auditing procedures) and while Anita can do that for the date of the most recent balance sheet, they can’t go back in time and observe inventory at the beginning of the period audited. So now, even with excellent financial accounting controls and without anyone being at fault in any way, the audit opinion of Anita Accountants has to include a “disclaimer of opinion” with respect to inventory.
And that can’t be accepted by the SEC for the Tier 2 filing (and probably not by any state requiring audited financials in a Tier 1 offering). Conversations with the SEC accounting Staff indicate that the Staff is unlikely to give any waivers in these circumstances.
So, any company interested in a Regulation A offering should do this: Before you even start the process, make sure you know whether the independent auditors who will review your financial statements are able to give a “clean” audit opinion. Find out the answer to this before starting any “testing the waters” (TTW) activities, because Tier 1 TTW activities are subject to more limitations than Tier 2, and you need to know which Tier you are going to choose before you start TTW.
Sara Hanks, co-founder and CEO of CrowdCheck, is an attorney with over 30 years of experience in the corporate and securities field. CrowdCheckprovides due diligence and compliance services for online alternative securities offerings. Its services help entrepreneurs and project sponsors through the disclosure and due diligence process, give investors the information they need to make an informed investment decision and avoid fraud and help intermediaries avoid liability. Sara’sprior position was General Counsel of the bipartisan Congressional Oversight Panel, the overseer of the Troubled Asset Relief Program (TARP). Prior to that, Sara spent many years as a partner of Clifford Chance, one of the world’s largest law firms. While at Clifford Chance, she advised on capital markets transactions and corporate matters for companies throughout the world.Sara began her career with the London law firm Norton Rose. She later joined the Securities and Exchange Commission and as Chief of the Office of International Corporate Finance led the team drafting regulations that put into place a new generation of rules governing the capital-raising process. Sara received her law degree from Oxford University and is a member of the New York and DC bars and a Solicitor of the Supreme Court of England and Wales. She serves on the SEC’s Advisory Council on Small and Emerging Companies. She holds a Series 65 securities license as a registered investment advisor. Sara is an aunt, Army wife, skier, cyclist, gardener and animal lover.
WATCH: Sara @ CrowdFunding USA 2015 National Press Club in DC