Consents, Part 1

Your eccentric client Jeff “The Dude” Lebowski is on the line. The Dude’s latest venture, a chain of bowling lanes, has taken off, and The Dude is anticipating issues for the IPO. The Dude wants you to prepare him for a meeting with his auditors (and bowling team members), Sobchak & Kerabatsos, to go over some questions about the required auditor’s consent for the IPO registration statement.

The consent story begins with Section 7 of the Securities Act. Section 7(a) states that the issuer must file the written consent of any accountant, engineer, appraiser and any person “whose profession gives authority” to his or her statements (i.e., an “expert,” even though the Securities Act technically does not define the term) if the registration statement names the expert as having prepared or certified (i) any part of the registration statement or (ii) any report or valuation used with the registration statement. Rule 436 of the Securities Act provides more detail and provides some exceptions to the consent requirement. For example, counsel for the underwriters or selling security holders do not need to file a consent even if named as having served in that capacity.
Liability issues

Section 7 works hand-in‑glove with Section 11 of the Securities Act. Section 11(a) imposes liability on a list of persons for material misstatements or omissions in the registration statement at the time of its effectiveness. The list includes the issuer and everyone else who signs the registration statement, directors, underwriters and any expert “who has with his consent been named” in the registration statement.

Section 11(b) provides a limited defense from Section 11(a) liability depending on the part of the registration statement and the nature of the defendant (other than issuers). Section 11(b)(3) bifurcates the registration statement into expertized and non-expertized parts. An expertized part (think audited financials) purports to rely on an expert’s authority, whereas a non-expertized part does not. Section 11(b)(3) also differentiates among types of defendants.

In particular, Section 11(b) provides that:

Underwriters, directors and other non-experts will avoid liability:

  • for non-expertized parts of the registration statement, if they prove that they had, “after reasonable investigation,” reasonable grounds to believe and did believe that the relevant part contained no material misstatement or omission (the “due diligence defense”); and
  • for expertized parts, if they prove that they had no reasonable ground to believe, and did not believe, that the relevant part contained a material misstatement or omission.

Auditors and other experts will avoid liability:

  • for their own expertized parts (e.g., the financials covered by the audit opinion in the case of auditors), if they prove that, after reasonable investigation, they had reasonable ground to believe and did believe that the relevant part contained no material misstatement or omission.

As you can see, an expert has to show reasonable investigation with respect to its expertized statements, whereas a non-expert essentially needs only show reasonable reliance in the case of expertized statements. The distinction is critical, because it works to lower the level of liability of, say, an underwriter with respect to expertized parts of the registration statement such as audited financial statements.
You mentioned registration statements. Does Section 7 apply to free writing prospectuses?

No, unless they are filed as part of the registration statement. In other words, even though FWPs are a permitted form of statutory prospectus (a Section 10(b) prospectus, if you are keeping score) and in many cases are filed, they do not represent a part of the registration statement at effectiveness. See C&DI 233.06. FWPs are not part of the Section 11 file–instead, they are part of the Section 12(a)(2) file. For a further discussion of the difference between these two categories of disclosure, have a look at our client alert on upsizing and downsizing an IPO.

Of course, it is possible to include an FWP as part of a registration statement and bring it within the Section 11 file – for example, by filing the FWP as an exhibit or incorporating it by reference. In that case, the Section 7 consent requirement would apply to the FWP as well.
How about things like Rule 134 communications?

No. Remember that Rule 134 is an exemption from the definition of “prospectus.” Anything that is not a prospectus (or an “offer,” given that Section 2(a)(3) defines a prospectus as a written offer) is not part of the Section 11 file.
For my IPO, do I need to file an auditor’s consent with each Form S-1 amendment?

Generally yes as a matter of contract, though not as a matter of law. Most auditor engagement letters require the issuer to obtain the auditor’s consent before each filing. Contrast this with the SEC Staff’s position, which is that a new consent is required:

  • Whenever any change, other than typographical, is made to the financial statements;
  • For an amendment if there have been intervening events since the prior filing that are material to the company; and
  • Before effectiveness of a registration statement if an extended period of time (generally any period of more than 30 days) has passed since the last filing.

See the SEC Staff Financial Reporting Manual (FRM) Item 4810.3.

For my Form 10-K, do I need to file an auditor’s consent?

It depends whether the company has an effective Securities Act registration statement for which the Form 10-K will act as a Section 10(a)(3) update. If so, you would need a consent. Otherwise, no consent is needed. See FRM Item 4810.4.
For a foreign private issuer filing a Form 20-F as an Exchange Act registration statement (i.e., an FPI listing its securities in the United States but not yet raising capital), do I need to file an auditor’s consent?

Yes. See FRM Item 4810.4.a. The SEC Staff takes this position even though, as a general rule, a pure Exchange Act registration statement (such as a Form 10) does not require an auditor’s consent. See Regulation S-K Item 601 Exhibit Table (Item 23).
For my public company exchange offer on Form S-4, can I simply incorporate by reference from the consent filed with the 10-K?

No. The SEC Staff takes the position that Regulation S-K Item 601(b)(23) does not permit incorporation from a consent filed with an Exchange Act report into a Securities Act registration statement that becomes effective after the Exchange Act report was filed. See C&DI 146.07.

Tune in also to Part 2 and Part 3, where the plot gets thicker, and we tackle thorny questions such as shelf takedowns and the Dude’s missing carpet.

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