SEC comment letters improved disclosures and tax payments, study finds

LAWRENCE — U.S. public companies since 2004 that received a Securities and Exchange Commission comment letter referencing tax-related issues were more likely to subsequently disclose more tax-related information to investors and increase cash payments to the IRS, according to a recent study that includes a University of Kansas researcher.

The analysis documented a spillover effect of one regulatory action in the accounting industry and illustrated perhaps the effectiveness of the comment letters the SEC has been using following the Sarbanes-Oxley Act and accounting scandals of the late 1990s, said Tom Kubick, assistant professor of accounting in the School of Business.

"We found it really interesting that a governmental agency like the SEC who is charged with making sure that disclosures are useful to investors and doesn't have a primary interest to make sure companies are paying more taxes, could issue something in a comment letter that could ultimately help another government agency, the IRS," Kubick said.

The Accounting Review published the researchers' findings in November. The SEC is primarily concerned with the financial reporting and disclosure of information in companies' annual reports to ensure transparency for investors. It typically sends letters to public companies requesting additional disclosure or clarification of existing disclosure, Kubick said.

The letters are publicly available on the SEC's website, and the researchers examined them in conjunction with annual reports of publicly traded companies. They determined that between 2004-2012 there was a positive association between the propensity to receive a tax-related comment letter and tax avoidance. 

After receiving a tax-related comment letter, firms increased the amount of tax information disclosed in their annual SEC filings compared with firms that did not receive a tax-related SEC letter. Specifically, companies that received tax-related SEC letters were more likely to increase the length of their income-tax footnotes and the number of references to tax issues, Kubick said.

"Public companies don't want to upset the SEC," he said. "The comment letters appear to be generating improved disclosure and more quality and consistency in these reports, which is an objective of the SEC."

He said researchers did not expect to find that companies receiving a comment letter also increased their cash-effective tax rate, which reflects payments to the IRS, by approximately 1.5 percentage points.

"The companies under scrutiny are not only making changes to their disclosures, but they seem to be pulling back on tax positions that have a real effect on money that gets sent to the IRS," Kubick said.

The effects of comment letters are beginning to receive more attention in academic research, he said, and findings that they can perhaps positively assist multiple government agencies in their aims would likely be of interest as a tactic to regulators.

It informs legislators on how effective the SEC is in getting companies to disclose tax-related information as well as possibly allowing tax authorities to use the SEC process to determine which firms to target for potential audits. Also, the letters appear to put more information in the hands of potential investors as they seek to make decisions with their money.

The study also found that the SEC comment letters perhaps influence the behavior of companies that don't even receive one.

"We found instances where companies did not receive a letter, but if they operate in an industry where several firms were receiving tax-related SEC letters, they actually increase their reported income-tax expense," Kubick said. "We interpreted that as possible attempts for such companies to avoid SEC scrutiny when it’s high. These particular companies don't increase their cash payments, which would be of interest to the IRS, but the increase in reported expense potentially says something about the disclosure decisions they are making."

Photo: Members of the Public Company Accounting Oversight Board under the U.S. Securities and Exchange Commission conduct a budget hearing. The Sarbanes–Oxley Act of 2002 created the board to oversee the audits of public companies to protect the interests of investors and the public in wake of the accounting scandals of the 1990s. The legislation also spurred the SEC to issue comment letters to companies about their tax practices, and a group of researchers that includes University of Kansas assistant professor of accounting Tom Kubick found the letters have increased the amount of tax information companies disclose as well as increasing the amount of tax payments to the IRS. Photo via the SEC.