Textual classification of SEC comment letters
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Textual classification of SEC comment letters James P. Ryans 1 Accepted: 7 September 2020/ # Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract This study examines the impact of SEC comment letters on future financial reporting outcomes and earnings credibility. Naïve Bayesian classification identifies comment letters associated with future restatements and write-downs. An investor attention-based quantitative measure of importance, using EDGAR downloads, also predicts these outcomes. Disclosure-event abnormal returns, revenue recognition comments, and the number of letters in a conversation appear to be useful quantitative metrics for classifying importance in certain settings. This study also documents trends in comment letter topics over time and identifies topics associated with the textual and quantitative classifications of importance, providing insights into the factors that draw investor attention and that relate to future restatements and write-downs. Innocuous comment letters are associated with improvements in earnings credibility following comment letter reviews. Keywords SEC comment letters . Financial reporting quality . Enforcement . Text
classification . Restatements . Write-downs . Naïve Bayes . Latent Dirichlet allocation JEL D78 . G14 . G18 . G38 . M41 . M48
1 Introduction Securities and Exchange Commission (SEC) reviews of reporting companies’ annual financial reports represent a significant public enforcement activity relating to financial disclosure regulation in the United States. These reviews are conducted by the Division of Corporation Finance at least once every three years for all public issuers in accordance with Section 408 of the Sarbanes Oxley Act of 2002. The purpose of an annual report review is to ensure that the issuer complies with generally accepted accounting principles and SEC disclosure regulations. As such, annual report reviews represent a form of government oversight over financial reporting, rather than a traditional enforcement
* James P. Ryans [email protected]
1
London Business School, London NW1 4SA, UK
J. P. Ryans
activity, such as that conducted by the Division of Enforcement, which is designed to sanction wrongdoing (Heese et al. 2017). When an SEC examiner finds one or more issues worthy of a request for clarification, change, or additional disclosure, he or she issues a comment letter requesting a reply within 10 days. The issuer replies in writing and can request an extension where the 10-day timeframe is not feasible. These documents, filed on form UPLOAD for SEC comments, and on form CORRESP for company responses, are publicly available on the SEC’s EDGAR web site. The purpose of this study is to better understand the nature and impact of comment letters on financial reporting and firms’ information environment. Comment letters are one of the primary disclosure compliance mechanisms for the US securities regulator. The SEC devotes considerable resources to conducting the reviews that generate comment letters, and issuers incu
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