Municipal Securities Offerings: Auditor Involvement and Other Key Considerations

1. Municipal Securities Offerings: Auditor Involvement and Other Key Considerations A Governmental Audit Quality Center Web Event October 15, 2013

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3. Administrative Notes • We encourage you to submit your technical questions – please limit your questions to the content of today’s program • You can submit your questions at any time during this Web event by clicking on the “Q & A” tab on the lower right-hand side of your screen • You can also download slides in PDF or PowerPoint by clicking on “Handouts” tab

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5. Continuing Professional Education • At the end of today’s presentation we will provide steps for obtaining your CPE certificate • Contact the Service Center for help with obtaining CPE at 888.777.7077 or service@aicpa.org • If you are not receiving CPE for this event, ignore the pop-up markers if they appear.

6. Presenters Joel Black Mauldin & Jenkins CPA’s Dan O’KeefeMoore Stephens Lovelace, P.A.

7. Agenda • Setting the stage • Auditor involvement in bond offerings • “Triggers” • Voluntary association • Non-association • Comfort letters • Inclusion letters • Special financial reporting situations • Involvement with continuing disclosure documents • SEC developments • New players • Report to Congress on muni market regulation • Increased enforcement activity • Municipal advisor registration

8. Glossary

9. Glossary

10. Setting the stage

11. Overview of municipal securities regulatory framework today • Existing exemptions • Muni securities generally exempt from Securities Act of 1933 registration requirements • State and local governments generally exempted from Securities Exchange Act of 1934 reporting requirements • However, no exemptions provided from the anti-fraud provisions of either the ’33 or ‘34 Acts • SEC’s limited authority over municipal market is derived from • Ability to prohibit underwriters from purchasing muni bonds unless issuer covenants to provide certain information to investors at initial issuance and throughout life of the bonds (SEC Rule 15c2-12) • Enforcement authority over anti-fraud provisions

12. EMMA allows "one-stop shopping" for municipal bond offering documents, periodic disclosure documents, and real-time pricing information • Through EMMA, the investing public can obtain information virtually real-time, free of charge (similar to the level of information available through EDGAR for SEC-registered securities) • www.emma.msrb.org

15. Auditor involvement in bond offerings

16. Phases of a muni offering • Preliminary official statement (POS) • Issued to all prospective buyers of the securities • Official statement (OS) • Issued at time of sale • Identifies the debt service requirements • Changes from POS typically not significant • Closing date • Transaction is finalized and cash is transferred from the buyers to the government

17. Auditor involvement with official statements (OS) • “Auditor” refers to the party whose audit report accompanies the external financial statements included in the bond offering document

18. Sources of AICPA guidance for auditors • AICPA audit & accounting guides • State and Local Governments (AAG-SLV): Chapter 16, Auditor Involvement with Municipal Securities Filings • Health Care Entities (AAG-HCO): Chapter 7, Municipal Bond Financing • Not-for-Profit Entities (AAG-NPO): Chapter 10, Appendix A -- Municipal Securities Regulation • Appendices A & B of AU-C Section 925, Filings With the Securities & Exchange Commission Under the Securities Act of 1933 • AU-C Section 920, Letters to Underwriters and Other Requesting Parties

19. Recent developments • Historically, the “auditor involvement” guidance in the AICPA guides was considered to be requirements • In updating the guides for the clarity project, several “shoulds” in that guidance could not be linked back to an auditing standard • In July, ASB’s Audit Issues Task Force (AITF) approved establishing a task force to develop an auditing standard to address the criteria for auditor involvement in a muni offering and related auditor’s responsibilities, based on that guidance • Envisioned as a new muni-specific standard that would likely be very similar to AU-C 925, Filings under Federal Securities Statutes

20. Activities that trigger involvement (AAG-SLV 16.07) • Reviewing draft of OS at client's request • “Consenting” to use of report in OS (i.e., providing inclusion letter) • Issuing comfort letter, modified comfort letter, or agreed-upon procedures (AUP) report related to OS • Assisting in preparing financial informationincluded in OS • Signing (either manually or electronically) an auditor’s report for inclusion in a specific OS • Providing a “customized” auditor's report for inclusion in an OS • Performing attestation engagement relating to the debt offering

21. Activities that trigger involvement • “Consenting” to use of report in OS (AAG-SLV 16.21) • In muni offerings, a “consent” is called an “inclusion letter” • Issuance of an inclusion letter is not required by professional standards • If inclusion letter is requested, use language such as We agree to the inclusion in [identify the document] of our report, dated February 5, 20XX, on our audit of the financial statements of [name of entity]. • References: • Exhibit A of AU-C Section 925, “Filings With the U.S. Securities and Exchange Commission under the Securities Act of 1933”

22. Activities that trigger involvement • “Consenting” to use of report in OS (continued) • We are essentially updating our previously issued audit report through a new date • Add any matters discussed in the audit report (emphasis of matters, etc.) • Add consent to references to the auditor included in the offering document • Dated the date of the POS or OS for which consent is provided

23. Activities that trigger involvement • “Consenting” to use of report in OS (continued) • Resulting language for a consent may look like: We consent to the references made to our firm under the headings “Introduction – Professionals Involved in the Offering” and “Miscellaneous – Information In the Appendices” and the inclusion of our independent auditor’s report on the basic financial statements of Sample County (the “County”) as of and for the year ended December 31, 2012, included in Appendix A to the Preliminary Official Statement dated August 23, 2013 regarding the issuance of Sample County’s $50,000,000 General Obligation Bonds, Series 2012. Our report dated May 14, 2013 includes a reference to other auditors and to the implementation of a new accounting standard on the financial statement presentation and accounting for debt issuance costs. Our report makes reference to the report of other auditors for the County Board of Health, a discretely presented component unit, which represents 10% and 50%, respectively, of the assets and revenue of the aggregate discretely presented component units. The financial statements of the County Board of Health and the auditor’s report thereon were furnished to us, and our opinion, insofar as it relates to the amounts included for that entity, is based solely on the report of other auditors.

24. Activities that trigger involvement Requested by underwriter? N • Issuing a comfort letter/AUP (AAG-SLV 16.14 - .18) “Nothing came to our attention….” (negative assurance) Issue “SAS 72” letter (AU-C 920 Example A-2) Y Required representation letter provided? Y* Issue “SAS 76” letter (AU-C 920 Example Q) Modified comfort letter (no negative assurance) N Issue AUP report (AT 201) Report of findings *Rare “Comfort letters” and AUP (Non-’33 Act Offering)

25. Activities that trigger involvement • Issuing a comfort letter • Representation letter provided by the requesting party (discussed on previous slide) should be: - addressed to the auditor; - contain the statement, “The review process applied to the information relating to the issuer, is, or will be, substantially consistent with the due diligence process that we would perform if this securities offering were being registered pursuant to the Securities Act of 1933. We are knowledgeable with respect to that due diligence process.”; and - signed by the requesting party.

26. Activities that trigger involvement • Issuing a comfort letter • Procedures typically include: • Review of minutes • Statement regarding inquiry of management of whether certain financial balance have changed from the audited financial statement balances • May add agreed-upon procedures related to information in the offering document

27. Activities that trigger involvement • Issuing a comfort letter • Letter should state the following: - We had no responsibility for establishing (and did not establish) the procedures performed. - An audit of information discussed in the letter was not performed. - The procedures should not supplant any additional procedures the requesting party would undertake. - Restricted use type language regarding the use of the report. - We have no responsibility to update the letter.

28. Activities that trigger involvement • Issuing an Agreed Upon Procedures (AUP) Report: • Are not limited to underwriters and certain intermediaries as comfort letters are. • Typically relate to agreeing information included in the offering document to supporting documentation. • Procedures performed should be agreed to, in writing, by the addresses/recipients of the letter. • Follow appropriate attestation engagement standards (AT 201).

29. Activities that trigger involvement • Issuing an Agreed Upon Procedures (AUP) Report: • AUP Do’s and Don’ts: • Be specific about procedures - include what document the information was agreed to or how a recalculation was performed • Try to avoid general comments such as “we traced to a schedule provided by management” • Do not make any comment regarding financial information being in accordance with GAAP • If stub information is addressed, do not give reasons for variances – only disclose dollar amounts

30. Activities that trigger involvement • Issuing an Agreed Upon Procedures (AUP) Report: • Example procedure language showing tracing to different sources as well as breaking out details of calculations: • We compared the amounts as of December 31, 2008, 2009, 2010 and 2011 in the table included under the caption “Historical Capital Structure of the System” (page 31 of the Official Statement) to the audited financial statements of Sample County for the years ended December 31, 2008, 2009, 2010 and 2011. We compared the unaudited amounts as of December 31, 2012 to the trial balance of the Sample County Water and Sewerage Authority as of and for the year ended December 31, 2012. We recalculated the “Total Net Assets and Liabilities” by adding the “Total Liabilities” and “Total Net Assets” for each year. We recalculated the “Ratio of Long-Term Liabilities to Total Net Assets” by dividing the “Total Long-Term Liabilities” by “Total Net Assets” for each year. We recalculated the “Long-Term Liabilities as a Percentage of Total Net Assets and Liabilities” by dividing the “Total Long-Term Liabilities” by the “Total Net Assets and Liabilities” for each year. No exceptions were noted which would require further comment in this report.

31. Question #1. If we issue a consent for the inclusion of our audit report on financial statements then we are essentially updating our audit report through a new date. • True • False

32. Question #2. If we are issuing either type of comfort letter allowed in a municipal offering, then we can include negative assurance (i.e. Nothing came to our attention…) related to financial information of the issuing government. • True • False

33. Activities that trigger involvement • Assisting in preparing financial information included in OS • In this situation, financial information  does not refer to financial statements covered by the auditor's opinion or the required supplementary information (RSI) or supplementary information other than RSI accompanying those financial statements that the auditor already considered during his or her audit of the financial statements.

34. Activities that trigger involvement • Signing (either manually or electronically) an auditor’s report for inclusion in a specific OS • This refers to the auditor providing an auditor’s report with an original manual or electronic signature. It is not referring to a reproduction of an auditor's report that was manually or electronically signed. • For example, the underwriter or bond counsel may require a copy of the auditor's report with an original manual or electronic signature to file with the official closing documents for the offering.

35. Activities that trigger involvement • Providing a “customized” auditor’s report for inclusion in a specific OS • The reports required by Government Auditing Standards (Yellow Book) on ICFR and compliance with laws and regulations bear a “purpose alert” under AU-C 905, and typically are not included in an OS • In such situations, it is generally advisable for an OS to use an auditor's report on the financial statements that does not refer to the Government Auditing Standards audit or to the reports on ICFR and compliance, because those references (without inclusion of the reports) could confuse the users of the OS (AAG-SLV 16.13). • Thus, the auditor might provide a “plain-vanilla” GAAS audit report specifically for inclusion in the bond offering document.

36. Activities that trigger involvement • Performing an attestation engagement related to the debt offering • In connection with issuing bonds, the auditor may be engaged to attest to certain information specifically involved with the offering (see AAG-SLV 16.24) VERIFICATION OF MATHEMATICAL ACCURACY The accuracy of (i) the arithmetic computations supporting the conclusion that the principal amounts of, and interest earned on, the government obligations to be acquired with a portion of the proceeds of the Series 2012 Bonds, together with other monies, if any, are sufficient to pay the Redemption Price of and interest on the Refunded Bonds due through and including the Redemption Date and (ii) the mathematical computations supporting the conclusion that the Series 2012 Bonds will not be "arbitrage bonds" under the code, will be independently verified by ABC CPAs.

37. Activities that trigger involvement • Performing an attestation engagement related to the debt offering -- example • Parity letter (additional bonds test) • Prior offerings may require this type of report in connection with new bond issues that use the same revenue pledge as old bonds • Report indicates that certain criteria (typically a coverage ratio) would have been met in the prior year even with the new debt being issued • Format: AT 201 agreed-upon procedures report

38. Question #3. Which of the following does not constitute involvement by an auditor in a debt offering? • Providing a copy of the audit report – without modification – for inclusion in the offering document • Preparing an agreed-upon procedures report related to information included in the offering document • Being asked, by the issuer, if the auditor needs to be involved in an offering • Simply looking over the offering document at the request of the issuer – but not being asked to provided anything.

39. Question #4. If we are considered to be involved in an offering, then we should issue a consent letter. • True • False

40. Question #5. We should never change our audit report for inclusion in an offering document. • True • False

41. Procedures when auditor is involved • Ideally should be involved during POS preparation • Reading the O/S (AU-C 720) • Be alert for information that is materially inconsistent with what’s in the financial statements covered by the auditor’s report • “Keeping current” procedures related to auditor’s report (AU-C 560) • Read all available information relating to the entity's financial and accounting matters • Make inquiries • Inquire of legal counsel • Obtain a management representation letter related to subsequent events period

42. If the auditor is not involved • Best practice • Consider including a requirement in the engagement letter that any OS issued by the client with which the auditor is not involved will contain language clearly indicating that the auditor is not involved (AAG-SLV 16.12) • ABC CPAs, the independent auditor for the Town, has not been engaged to perform and has not performed, since the date of their report included herein, any procedures on the financial statements addressed in their report included in this Official Statement. ABC CPAs also has not performed any procedures relating to this Official Statement.

43. Describing the auditor’s role • If auditor’s role is described in the OS, use the following language: INDEPENDENT AUDITORS The financial statements as of December 31, 19XX and for the year then ended, included in this offering circular, have been audited by ABC, independent auditors, as stated in their report(s) appearing herein. • References: • AAG-SLV par. 16.20 • Exhibits A and B of AU-C Section 925, “Filings With the U.S. Securities and Exchange Commission under the Securities Act of 1933”

44. Describing the auditor’s role • Inappropriate references – “expertization” (AAG-SLV 16.20) The financial statements as of December 31, 19XX and for the year then ended, included in Appendix A of this offering circular, have been audited by ABC CPAs, independent auditors, as stated in their report appearing herein. EXPERTS INDEPENDENT ACCOUNTANTS Set forth in Appendix A are the consolidated financial statements of the District for the fiscal year ending June 30, 2011 as audited by ABC CPAs. These audited financial statements have been included in reliance upon the reports of such firm given their expertise in accounting and auditing.

45. Voluntary involvement (AAG-SLV 16.11) • Occurs when engagement letter requires client to request auditor’s permission to use auditor’s report in connection with a sale of securities • In such cases, auditor is involved even if no “mandatory” triggers have occurred “The Company may wish to include our report on these financial statements in a registration statement proposed to be filed under the Securities Act of 1933 or in some other securities offering. You agree that the aforementioned audit report, or reference to our Firm, will not be included in any such offering without our prior permission or consent. Any agreement to perform work in connection with an offering, including an agreement to provide permission or consent, will be a separate engagement.” • Important: Both parties should understand what constitutes “use of the report”

46. Can you spot the inconsistency? GENERAL CONSIDERATIONS • The District's financial statements for the year ended June 30, 2011, were audited by ABC CPAs, and have been included herein as Appendix A. ABC CPAs has agreed to the publication of its audit opinion on such financial statements in this OS. ABC CPAs has not been engaged to perform any updating procedures subsequent to the date of its audit report on the June 30, 2011 financial statements.

47. Special financial reporting situations • Common types of financial statements that might be requested for inclusion in an OS • Stub-period audits or reviews • Condensed financial statements • Fund financial statements

48. Common Sections of the Official Statement • Introduction, Plan of Financing, The Bonds • Gives overview of issuance, purpose of bonds, payment terms, etc. • The Issuer • Describes government similar to basic info. in the footnotes and MD&A – typically focuses on outstanding debt, financial history for last 5 years, property tax information, postemployment benefit plans, and insurance information • Legal Matters • Discloses pending litigation and other legal information affecting bonds

49. Common Sections of the Official Statement • Miscellaneous • Gives more detail on parties involved, including Independent Auditor’s • Appendix A • Typically the most recent audited financial statements of issuer • Other Appendices • Various documents such as legal opinion and certifications

50. Engagement Tips When Involved • Early communication with involved parties to determine what we will be performing • See if partial (basic) or complete FS will be included • Make sure they are including at least the full basic set of statements. • Use some type of standard work program to document procedures to be performed