Key Takeaways and Reminders for 2021 Form 10-K and Proxy Season

Bryan Cave Leighton Paisner
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The new year is well underway, and calendar year filers are knee deep in Form 10-K and proxy planning and drafting.  Highlighted below are some of the key issues and changes that companies should consider as they continue work on Form 10-K and proxy statement matters:

General

2021 Board Self-Evaluations.  As discussed in our January 7, 2021 post, as boards of directors prepare for and conduct their 2021 self-evaluations, they should consider adding to their evaluation processes questions/discussion topics addressing the board’s ability to govern effectively in the face of the COVID-19 pandemic, as well as emerging areas of investor focus, such as diversity and inclusion, disruption/innovation, crisis preparedness, geopolitics, cybersecurity and privacy, virtual board meetings, and environmental, social and governance (“ESG”) initiatives.  Our January 7, 2021 post includes sample supplemental questions/discussion topics for such board self-evaluations.

2021 D&O Questionnaires.  As discussed in our September 10, 2020 post, companies should consider whether to update or supplement their 2021 D&O questionnaires to gather information in response to the growing pressure from investors, proxy advisors, activists, and others for voluntary diversity disclosures.  As pressures for diversity mount and some companies publicly pledge to add diverse directors to their boards within one year, the annual D&O questionnaire can be a useful way to document the issue and provide a basis for any voluntary disclosures a company may decide to make.

Risk Factors.  In preparing this year’s Form 10-K risk factors and in addition to considering the SEC’s 2020 guidance and amendments to disclosure rules noted below, companies should review their existing Form 10-K and 10-Q risk factors to consider whether new risks have emerged, hypothetical risks have become real, or existing risks have changed.  Our April 29, 2020 post discusses COVID-19 related risk factor preparation and disclosure approaches.

Forward-Looking Statements.  Companies should review the substance and priority of the factors included in their forward-looking statements disclaimers in the Form 10-K, including the disclaimers relating to COVID-19, with careful attention to tailoring the listed factors to the specific forward-looking statements in the Form 10-K.

Form 10-K – Certain SEC Rule Changes, Guidance and FAQs

Cover Page.  Effective April 27, 2020, the Form 10-K cover page was amended to add a box that is required to be checked if the Form 10-K includes an auditor attestation on the company’s internal control over financial reporting.  The current Form 10-K published by the SEC can be found here.  The text accompanying the new check box states:

“Indicate by check mark whether the company has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.”

Definitions of Large Accelerated Filer and Accelerated Filer.  Also effective April 27, 2020, in March 2020, the SEC approved amendments to Rule 12b-2 under the Exchange Act to amend the definitions of “large accelerated filer” and “accelerated filer.”  The amendments are intended to reduce the reporting and compliance burdens and costs for certain smaller filers.  Most significantly, as a result of the amendments, certain smaller reporting companies will be exempted from the requirement to provide the auditor assessment of the effectiveness of internal control over financial reporting that is required under Section 404(b) of the Sarbanes-Oxley Act of 2002.  In the March 12, 2020 press release reporting the changes, the SEC commented that the changes were made in order to “more appropriately tailor the types of issuers that are included in the categories of accelerated and large accelerated filers and promote capital formation, preserve capital, and reduce unnecessary burdens for certain smaller issuers while maintaining investor protections.”  The amendments, among other changes:

  • Exclude from the accelerated and large accelerated filer definitions an issuer that is eligible to be a smaller reporting company and that had annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available;
  • Increase the public float thresholds for an accelerated and a large accelerated filer becoming a non-accelerated filer from $50 million to $60 million and for exiting large accelerated filer status from $500 million to $560 million; and
  • Add a revenue test to the transition thresholds for exiting both accelerated and large accelerated filer status.

Electronic Signatures.  As reported in our November 24, 2020 post, in November 2020, the SEC approved amendments to Rule 302(b) of Regulation S-T, which governs the signing of “authentication documents” supporting typewritten signatures included in documents (e.g., Form 10-Ks) that are filed with the SEC electronically via EDGAR.  Rule 302(b), as amended, allows a signatory to use an electronic signature (as an alternative to a manual signature) on any such authentication document, provided certain requirements are met.  For example, prior to using an electronic signature in an authentication document for the first time, a signatory is required to manually sign a document attesting that he or she agrees that the use of an electronic signature in any authentication document will be the legal equivalent of such individual’s manual signature.  The amendments became effective on December 4, 2020.

Regulation S-K Amendments to Items 101 (Description of Business), 103 (Legal Proceedings) and 105 (Risk Factors)

In August 2020, the SEC adopted amendments to Regulation S-K that aim to modernize the descriptions of business (Item 101) and legal proceedings (Item 103), as well as risk factor disclosure requirements (Item 105).  The amendments reflect a principles-based approach in which disclosure objectives are set and management is permitted to exercise judgment on how to satisfy those objectives — tailored to the particular company — to the extent such information is material to an understanding of the topic.  The amended rules became effective on November 9, 2020 and are covered in our August 26, 2020 post and in more detail in our related August 26, 2020 client alert.  Following is a brief summary of the amendments:

Description of Business (Items 101(a) and (c)).  The amendments provide a non-exclusive list of the types of business information that a company may need to disclose based on a principles-based approach.  For example, under the revised rules, a company would describe its dependence on key products and services that are material instead of focusing on products and services that meet quantitative revenue thresholds as had been previously prescribed in Item 101 prior to its amendment.

The Item 101 amendments, among other changes:

  • Eliminate the look-back period in Item 101(a) – generally five years, or three years for smaller reporting companies — to focus on material developments in a company’s business, regardless of a specific time frame;
  • Revise and expand the list of disclosure topics in Item 101(c) with a principles-based, non-exclusive list of topics;
  • Require, to the extent material, new disclosures regarding “human capital resources,” which include any human capital measures or objectives that management focuses on in managing the business; depending on the nature of the company’s business and workforce, this would require disclosure of measures or objectives that address the attraction, development and retention of personnel; and
  •  Expand the previous requirement to disclose the impact of environmental regulations to cover the impact of all material government regulations.

As reported in our November 20, 2020 post, in November 2020, the SEC Staff (the “Staff”) published transitional FAQs addressing questions that had arisen regarding the amendments, including FAQs that relate to Form 10-K and that, insofar as they relate to Item 101 and Form 10-K, are summarized briefly below:

  • Business Description - Clarification of Time Period Covered.  As noted above, amended Item 101 requires that a company describe the general development of its business over the period for which information would be material – i.e., there is no defined time period.  Item 1 of Form 10-K, however, requires Item 101 disclosure for the period since the beginning of the fiscal year covered by the Form 10-K.  The FAQs clarify that amended Item 101 does not change the time period set forth in Item 1 of Form 10-K.
  • Conditions for Omitting Amended Item 101 Disclosure from Form 10-K.  The FAQs confirm that amended Item 101(a)(2) permits a company to omit full Item 101(a) (or Item 101(h) in the case of smaller reporting companies) disclosure from a Form 10-K, provided the company: (1) discloses in the filing all material business developments occurring since the most recently filed registration statement or report that includes full Item 101(a) disclosure, (2) includes a hyperlink to such filing, and (3) incorporates such full disclosure by reference to such prior registration statement or report.  The Staff noted that companies are not required to use this updating method, and that it anticipates that the method will be used mainly in registration statements (i.e., rather than Form 10-K filings). 

Legal Proceedings (Item 103).  The Item 103 amendments, among other changes:

  •  Clarify that hyperlinks or cross-references to legal proceedings disclosure elsewhere in the same document (e.g., in the notes to the financial statements) are permitted to avoid duplication; and
  • Establish alternative disclosure thresholds for environmental proceedings, where disclosure is now required for an environmental proceeding to which a governmental authority is a party if the proceeding involves potential monetary sanctions, unless the company reasonably believes the proceeding will result either in no monetary sanctions or in monetary sanctions, exclusive of interest and costs, of less than:
    • $300,000 or more – tripled from the previous $100,000 level; or
    • At the election of the company, such other amount that the company determines is reasonably designed to result in disclosure of any such proceeding that is material to its business or financial condition; provided, however, that the threshold may not exceed the lesser of $1 million or 1% of the current assets of the company on a consolidated basis.

Risk Factors (Item 105). The Item 105 amendments, among other changes:

  • Require a summary — that does not exceed two pages — if the risk factors section exceeds 15 pages;
  • Replace the disclosure standard from “most significant” to “material” risk factors to focus on factors that make an investment in the company or offering speculative or risky; and
  • Require risk factors to be organized under relevant headings in addition to the sub-captions previously required, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption (i.e., “General Risk Factors”).

COVID-19 Related Disclosures

MD&A and Other Disclosures.  As reported in our April 2, 2020 post, in March 2020, the Division of Corporation Finance issued COVID-19 related guidance (Topic No. 9) regarding disclosure and other securities law obligations related to COVID-19 and resulting business and market disruptions.

As reported in our June 24, 2020 post, in June 2020, the Division of Corporation Finance issued supplemental guidance (Topic No. 9A) calling for companies to assess and disclose in MD&A (including in Form 10-K) the evolving impact of COVID-19 on their operations, liquidity and capital resources.  The supplemental guidance states that the Division of Corporation Finance is monitoring how companies are addressing COVID-19 related disclosures and encourages public companies to provide meaningful disclosures of the current and expected impact of COVID-19 through the eyes of management.  The key topics covered by the guidance include the effects of the pandemic on a company’s operations, liquidity and capital resources (as noted above); the short and long-term impact of any federal relief received under the CARES Act; and the company’s ability to continue as a going concern.  The guidance included a non-exclusive list of types of impact to be considered, including without limitation material operational challenges, covenant compliance in credit and other agreements, and any material reduction or increase to human capital resource expenditures.

Non-GAAP Financial Measures.  Another COVID-19 related disclosure challenge includes whether and how to adjust GAAP financial measures to take into account the financial impact of COVID-19, thereby generating a non-GAAP measure.  Given the SEC’s high level of scrutiny in this area, companies that wish to disclose non-GAAP measures in their Form 10-K (and/or earnings releases), should be prepared to explain and support the quantification of any such adjustments and their rationale for the adjustments.  The SEC’s guidance with regard to COVID-19 related non-GAAP includes CF Disclosure Guidance: Topic No. 9A, as described in our June 24, 2020 post, and CF Disclosure Guidance: Topic No. 9 as described in our April 2, 2020 post.  We also discussed COVID-19 related non-GAAP financial measures in our August 18, 2020 post.

With regard to non-GAAP measures generally, the Staff has taken the position that “presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a company’s business could be misleading.”  Therefore, as the pandemic continues and operating practices change, companies that have disclosed or plan to disclose non-GAAP financial measures that exclude COVID-19 related expenses should consider whether any of their COVID-19 related expenses, such as supplies, cleaning and sick pay, might no longer be viewed as unusual or non-recurring.

Penalties for Misleading COVID-19 Disclosure.  As reported in our December 7, 2020 post, the SEC, in its first enforcement action against a public company for misleading disclosures regarding COVID-19’s business impact, released a December 4, 2020 Order Instituting Proceedings against The Cheesecake Factory Inc. in which the SEC accepted the filer’s offer of settlement for a civil penalty of $125,000.  As recounted in the SEC’s Order and as described in more detail in our December 7, 2020 post, the SEC determined that the filer’s disclosures repeatedly made materially false and misleading statements about the effect of the COVID-19 pandemic on its business.  While just the first of its kind, this action is consistent with the Division of Corporation Finance’s March 25, 2020 Disclosure Guidance that cautioned reporting companies regarding disclosure of both COVID-19’s risks and COVID-19’s impact on their businesses.  When crafting their own Form 10-K and other disclosures of the pandemic’s impact and related risks, companies should consider this action.

Proxy Statements

COVID-19 Related Perquisites.  Perquisites have been, and will continue to be, an area of SEC focus.  We urge companies to give careful thought to any new benefits provided to executives during the COVID-19 pandemic and to clearly document why they believe such benefits are or are not perquisites or personal benefits for purposes of executive compensation proxy disclosures.  As discussed in our September 22, 2020 post, in September 2020, the SEC Division of Corporate Finance issued new Regulation S-K guidance, CD&I 219.05, to help public companies determine whether benefits provided to executive officers because of COVID-19 should be disclosed as perquisites or personal benefits for purposes of executive compensation proxy disclosures.  Consistent with Release 33-8732A, the guidance confirms that an item provided because of the COVID-19 pandemic is not a perquisite or personal benefit if it is “integrally and directly related to the performance of the executive’s duties,” which depends on the particular facts.

The CD&I states:  “In some cases, an item considered a perquisite or personal benefit when provided in the past may not be considered as such when provided as a result of COVID-19.  For example, enhanced technology needed to make the NEO’s home his or her primary workplace upon imposition of local stay-at-home orders would generally not be a perquisite or personal benefit because of the integral and direct relationship to the performance of the executive’s duties.  On the other hand, items such as new health-related or personal transportation benefits provided to address new risks arising because of COVID-19, if they are not integrally and directly related to the performance of the executive’s duties, may be perquisites or personal benefits even if the company would not have provided the benefit but for the COVID-19 pandemic, unless they are generally available to all employees.”

Proxy Advisors - 2021 Policy Updates and Guidance.  Institutional Shareholder Services (“ISS”) and Glass Lewis have released their respective policy updates for the 2021 proxy season.  The ISS updates can be found here, and the Glass Lewis updates can be found here.  Key updates are summarized in our December 11, 2020 post.  The updates reflect, among other things, a heightened focus on board diversity and on board oversight of environmental and social (i.e., “E&G”) issues.  ISS also published FAQ guidance addressing how it will approach COVID-related pay decisions under its pay-for-performance qualitative company evaluations.

Description of Diversity Commitment in Proxy Statements.  As discussed in our August 10, 2020 post, in 2020, shareholders of a number of companies filed derivative lawsuits against the directors and officers of the companies alleging false and misleading proxy disclosures regarding the companies’ commitment to diversity (i.e., alleging that the companies have failed to deliver on those commitments).  The lawsuits also allege, among other things, that the companies’ directors breached their fiduciary duties by, for example, failing to oversee compliance with anti-discrimination laws and/or failing to ensure the inclusion of diverse individuals on the board.  With these lawsuits in mind, boards should continue to monitor compliance with employment laws and pay attention to the boards’ and the issuers’ diversity and inclusion efforts, as well as diversity related commitments and disclosures in the issuers’ proxy statements.  Boards should ensure that companies create an appropriate record for diversity related commitments and disclosures in their proxy statements and other filings.  Companies should continually evaluate their public statements regarding such matters to ensure the statements provide an accurate presentation of diversity programs and do not provide unsubstantiated comments, as well as of their training programs relating to unconscious bias, racism, and diversity.

Virtual Annual Meetings of Shareholders.  As COVID-19 continues into 2021, many companies are planning to hold virtual or hybrid shareholder meetings.  Our November 3, 2020 post discusses virtual annual meeting requirements and considerations regarding matters such as meeting technology and logistics, proxy statement disclosures, state law, ISS and Glass Lewis 2020 policies and guidance, and lessons learned in 2020.  Our December 11, 2020 post also includes a brief summary of ISS’ and Glass Lewis’ 2021 policy updates related to virtual annual meetings.

Certain Upcoming Changes

Regulation S-K Amendments – Items 301, 302 and 303 (MD&A and Related Financial Disclosures).  As reported in our November 23, 2020 post and discussed in more detail in our November 23, 2020 client alert, in November 2020, the SEC adopted significant amendments to MD&A and related financial disclosures.  In adopting the amendments, the SEC’s aim, consistent with its aim in adopting amendments to Regulation S-K Items 101, 103, and 105 earlier in the year, was to streamline disclosures and move to a more “principles-based approach,” focused on material information for the benefit of investors.

The amendments will become effective on February 10, 2021, and companies will be required to comply with the amended rules beginning with their first fiscal year ending on or after August 9, 2021 (for each company, its “mandatory compliance date”).  Although companies need not apply the amended rules until their respective mandatory compliance dates, they may comply with them any time after the effective date, so long as they provide disclosure responsive to an amended item in its entirety.

Among other things, the amendments:

  • Eliminate Item 301 (Selected Financial Data);
  • Simplify Item 302(a) (Supplementary Financial Information) by replacing the current requirement for quarterly tabular disclosure with a principles-based requirement for material retrospective changes); and
  • Simplify Item 303 (MD&A) as follows:
    • Adding a new Item 303(a), Objective, to state the principal objectives of MD&A;
    • Amending current Items 303(a)(1) and (2) (amended Item 303(b)(1)) to update, enhance and clarify disclosure requirements for liquidity and capital resources;
    • Amending current Item 303(a)(3) (amended Item 303(b)(2)) to clarify and streamline disclosure requirements for results of operations;
    • Adding a new Item 303(b)(3), Critical accounting estimates, to clarify and codify SEC guidance on critical accounting estimates;
    • Replacing current Item 303(a)(4), Off-balance sheet arrangements, with an instruction to discuss such obligations in the broader context of MD&A;
    • Eliminating current Item 303(a)(5), Tabular disclosure of contractual obligations, in light of the amended disclosure requirements for liquidity and capital resources and certain overlap with information required in the financial statements; and
    • Amending current Item 303(b), Interim periods (amended Item 303(c)) to clarify and streamline the item and allow for flexibility in the comparison of interim periods to help companies provide a more tailored analysis relevant to business cycles.

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