COVID-19 Considerations. As companies prepare their annual reports, they should consider refreshing their various disclosures about COVID-19. Particular attention should be given to COVID-19 disclosures in the MD&A, Risk Factors and Business sections in the Form 10-K. Companies should consider whether what was previously a trend or uncertainty at the time of prior filings may have evolved in a standard business practice or attribute of the company’s business. In addition, companies should consider whether new risks or uncertainties have arisen and should be discussed, whether caused in whole or part by COVID-19. For example,
- Risks to human capital resources arising from vaccine mandates, including employee attrition and potential costs of compliance where a company offers a testing alternative;
- Supply chain constraints;
- Labor and materials shortages; and
SEC Comment Letter Trends. During the 12 months ended June 30, 2021, the first and second most common comment areas by the SEC were non-GAAP financial measures (also number 1 in the prior fiscal year), followed by MD&A (also number 2 in the prior fiscal year).2 Of note, there was very little movement in the top 10 comment areas with most areas moving up, or down, only one spot.3 The one exception was that comments about signatures/exhibits/agreements moved up to number 6 in 2021, from number 10 in 2020.4 According to Ernst & Young, other common comment areas included segment reporting, revenue recognition, fair value measurements, goodwill and intangible assets, contingencies, inventory and cost of sales and income taxes.5
With respect to non-GAAP measures, the SEC has issued comments questioning whether companies are improperly treating certain financial measures as key performance indicators (“KPIs”), where they should be identified as non-GAAP measures and reconciled to the most comparable GAAP measure. Also, the SEC continues to focus on individual tailored accounting principles and may object to their presentation where the SEC believes they may be misleading. Of particular note, the SEC often objects to measures that they believe are an alternative presentation of revenue (e.g., gross revenue or a measure that accelerates the recognition of deferred revenue).
ESG Disclosures and Considerations. The push for increased disclosure of environmental, social and governance (“ESG”) topics in annual reports and proxies has never been higher. While the “G” component of ESG has been addressed extensively in proxy statements/annual reports for many years, there continues the rapidly growing evolution to present substantially broader disclosures about the “E” and “S” components, including climate change, environmental protection, sustainability, and racial and social justice, as well as income and gender inequality.
As indicated, the SEC has made clear that it intends to propose new disclosure requirements related to climate change and other sustainability issues.
In addition, the SEC continues its enforcement of existing climate disclosure requirements. In March 2021, the SEC announced the creation of a Climate and ESG Task Force at the Division of Enforcement to proactively identify ESG-related misconduct. The SEC’s initial focus is to “identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.”6
Cybersecurity. The SEC continues to scrutinize how companies are addressing cybersecurity in their periodic and other reports. During 2021, the SEC announced that it was considering new rulemaking concerning cybersecurity risk disclosures. As companies prepare their 2021 Form 10-Ks, they should consider their existing cybersecurity disclosures. Although the most obvious section is Risk Factors, companies should consider based on their circumstances whether cybersecurity should be discussed in the Business section of the Form 10-K. With respect to risk factors, companies should consider whether new risks have arisen, as well as whether previously disclosed “theoretical” risks have metamorphosed into actual cyber events. If so, the SEC has made clear it considers it misleading to continue to label or characterize the risks as “theoretical.”
Modernization of Regulation S-K. As discussed above under “SEC Reporting Update”, the SEC’s modernized Regulation S-K, Item 303 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) is effective for this year’s annual reports on Form 10-K. Although from a substantive standpoint, the new rules should generally guide to similar disclosure, the changes were not insubstantial and companies should carefully review the new disclosure regime and guidance when drafting this year’s MD&A.
1 See e.g., Letter From Human Capital Management Coalition (Oct. 22, 2019), cited in Regulations S-K and ESG Disclosures: An Unsustainable Silence, SEC Commissioner Allison Herren Lee (Aug. 26, 2020).
2See Ernst & Young LLP, SEC Reporting Update, Highlights of trends in 2021 SEC comment letters (Sept. 2021).
6SEC Announces Enforcement Task Force Focused on Climate and ESG Issues, Press Release, United States Securities and Exchange Commission (March 4, 2021).